Creating Value and Improving Financial Performance: Inclusive Finance and the ESG Premium (Palgrave Macmillan Studies in Banking and Financial Institutions) by Paul Wachtel

1. The Market Reaction to Climate Risk: Evidence
from the European Banking Industry
Francesca Battaglia, Francesco Busato and Simone Taddeo
Department of Management Studies and Quantitative Methods, University of Naples
Parthenope, Naples, Italy
Department of Economic and Legal Studies, University of Naples Parthenope, Naples,
Italy
Francesca Battaglia
Email: francesca.battaglia@uniparthenope.it
Francesco Busato
Email: francesco.busato@uniparthenope.it
Simone Taddeo (Corresponding author)
Email: simone.taddeo001@studenti.uniparthenope.it
Keywords Carbon premium – Climate-transition risk – Stock returns – Climate change –
Carbon emission
1.1 Introduction
Nowadays, discussion on climate change is a widespread issue in the world debate. The
mean global temperature of the Earth has seen an increase of 0.87 ℃ since 1900 according
to Intergovernmental Panel on Climate Change (IPCC, 2014). At this rate, if detected
emission levels since 1950 continue to rise, global warming is likely to reach 1.5 ℃ above
pre-industrial levels between 2030 and 2052 (IPCC, 2018). The progressive increase in
global warming is destined to cause unstoppable catastrophes, provoking a significant
impact not only for humankind, but also for the ecosystem and natural resources. Scientific
articles by the IPCC reveal that one of the causes of global temperature rise is the
continuous increasing concentration of greenhouse gas emission in the atmosphere (IPCC,
2014).
A rise of the greenhouse gases concentrations in the air produces a significant climate
forcing, or warming effect. Over the period that goes from 1990 to 2019, the global
warming effect provoked by human activities’ greenhouse gases increased by almost 45%
(Environmental Protection Agency, 2021). Therefore, it is plausible to believe that one of
the reasons that the planet heats up is largely due to anthropogenic activities (human
activities), which is considered the biggest contributor to climate change (U.S. Global
Change Research Program, 2021). In order to reduce the global warming effect, one of the
main recommendations that scientists suggest is to lower greenhouse gas emissions,
encouraging the transition to a low-carbon economy (IPCC, 2014).
A first step toward the abatement of gas emissions was made by the Paris Agreement in
2015, an international treaty where most of the countries representing 97% of worldwide
greenhouse emissions, agreed to keep global warming below 2 ℃, preferably at 1.5 ℃,
compared to pre-industrial levels. The Paris Agreement, which represents a real milestone
for combating climate change, raised awareness among policymakers, academics, financial
institutions and companies regarding the variability of weather’s temperatures as a future
challenge and concrete threat in the next decades (ESRB, 2016). The Paris treaty can be
considered the first climate deal that has contributed to rethinking a new way of doing
business by favoring the transition from an economy with a high greenhouse gas emission
to a low-fossil-fuel-economy (LFFE) or commonly called low-carbon economy.
One of the three long-term goal commitment of the agreement, indeed, was to “making
finance flows consistent with a pathway towards low greenhouse gas emissions and climate-

resilient development” (Paris Agreement, Article 2.1c).
 In this context, the European Union
has taken giant steps in reducing its greenhouse gas (GHG) emissions. The latest statistics
show that GHG emissions in Europe have decreased sharply in the last years, reaching 24%
below 1990 levels, which is expected to be 31% in 2020 (European Environment Agency,
2021). This is attributable not only to the transition of the use of fossil fuels to a clean
energy source (such as renewable resources), which has led to structural changes in
European economies, but also to the implementation of EU and national policies and
regulations. On 7 March 2018, indeed, the European Commission launched one of the most
important action plans for financing sustainable growth, facilitating the transition to a low-

carbon economy by increasing investments in green projects and promoting a new financial
sustainability strategy in the long-term.
The policy is well-known under the name of Sustainable Finance Action Plan, whose
ultimate goal is to shape the financial system in a way to support the sustainable transition.
The Action Plan recommends three key objectives to be taken at European level. The first
purpose is to redirect cash and capital flows toward sustainable investments shifting away
from those activities and sectors that make intensive use of fossil fuels that encourage the
global warming issue. The second goal is to manage financial risks deriving from climate
change, resource depletion and environmental degradation. The third aim is to enhance the
transparency and long-termism in each financial activity as to realize sustainable and
inclusive growth. These three objectives are divided into ten actions which include
initiatives on various fronts with the aim of involving all the players in the financial system
in reducing information asymmetries related to climate risks, thus improving the allocation
of capital to sustainable investments. In detail, the scope of the action plan encourages to
better classify economic activities along with an appropriate EU sustainable taxonomy,
clarifying to all market participants, such as asset managers, pension funds, and European
banks their responsibilities regarding sustainability. This allows the possibility to assess the
feasibility of including the risks associated with the climate and other environmental factors
in the risk management policies.

Creating Value and Improving Financial Performance: Inclusive Finance and the ESG Premium (Palgrave Macmillan Studies in Banking and Financial Institutions) by Paul Wachtel