Ecological, Societal, and Technological Risks and the Financial Sector

Thomas Walker, Dieter Gramlich, Mohammad Bitar, Pedram Fardnia, Thomas Walker, Dieter Gramlich, Mohammad Bitar, Pedram Fardnia

• Publisher: Palgrave Macmillan
• Year: 2020
• ISBN:
  9783030388584
• Topic: Business
• Subtopic: Financial Risk Management
• Index: Business

Today's financial sector faces multiple challenges stemming from ecological, societal, and technological risks such as climate change, political extremism, and cyber-attacks. However, these non-traditional risks are yet to be fully identified and measured, in order to ensure their successful management. This edited collection sheds light on the topic by examining the unique measurement and modelling challenges associated with each of these risks, and their interaction with finance.

Offering a comprehensive analysis of non-traditional finance risks, the authors provide the basis for developing appropriate risk management techniques. With new approaches to protect against emerging threats to the financial sector, this edited collection will appeal to academics researching sustainability, development finance, and risk management, as well as policy-makers and practitioners within the banking sector.

© The Author(s) 2020

T. Walker et al. (eds.)Ecological, Societal, and Technological Risks and the Financial Sector Palgrave Studies in Sustainable Business In Association with Future Earthhttps://doi.org/10.1007/978-3-030-38858-4_1

Begin Abstract

1. Emerging Risks: An Overview

Thomas Walker¹ , Dieter Gramlich² , Kalima Vico³ and Adele Dumont-Bergeron³

(1)

Department of Finance, John Molson School of Business, Concordia University, Montreal, Canada

(2)

Department of Banking, Baden-Wuerttemberg Cooperative State University, Heidenheim, Germany

(3)

John Molson School of Business, Concordia University, Montréal, QC, Canada

Thomas Walker (Corresponding author)

Email: [email protected]

Dieter Gramlich

Email: [email protected]

Kalima Vico

Adele Dumont-Bergeron

End Abstract

One of the core functions of financial institutions is risk management. Until recently, most institutions have focused on concepts such as cyclical variations in their business and the economy, their exposure to low and even negative interest rates, and the consequences of various other macroeconomic developments and internal decisions on their profit margins, solvency, and efficiency, among others. Our world is changing, and individuals and businesses are increasingly affected by factors that arise from outside the economy and the financial markets, yet display multiple interactions with the eco-financial system. Today—arguably more than ever—financial institutions face a variety of new challenges that require them to seriously rethink their risk management and investment practices. Climate change, mass migration, political extremism, trade wars, terrorism, cybersecurity threats, and the current evolution of financial technology (FinTech) are just some examples of ecological, societal, and technological factors that affect and interact with our financial markets. This book aims to highlight not only the threats but also the opportunities associated with these emerging risks, thereby providing an inspiration for academics, practitioners, and regulators who already work in or are interested in this field.

Our environment is rapidly changing: natural disasters, heat waves, and rising sea levels affect our personal lives as well as businesses and the overall economy; new technologies continuously reshape the way we communicate, entertain ourselves, and make purchase decisions; and globalization requires companies—many of which are increasingly spread out across continents—to rely on ever more complicated supply chains, transportation systems, and tax management. As a result, the public perception of sustainability is shifting and is paving the way for new business, investment, and regulatory approaches to address today’s ecological, societal, and technological challenges.

Almost all of the emerging risks discussed in this book come with their own unique opportunities and threats. For instance, Internet-based technologies facilitate the way we carry out business and conduct financial transactions. Yet, cybersecurity vulnerabilities and the hackers who exploit them can be highly detrimental to consumers as their personal and financial information can be compromised and potentially sold around the globe. Mobility is facilitated by ever faster land, air, and sea transportation; however, the consequences of energy consumption and carbon dioxide (CO₂) emissions have to be considered as well. With such a variety of new developments, firms and investors must adjust their behaviors and regulators must reconsider existing laws to better mitigate and adapt to the arising challenges. The adoption of a less carbon-intensive economy and the consideration of environmental, social, and governance (ESG) factors in business and investment decisions are two possible ways of reacting to these challenges from a risk management perspective.

Our financial, banking, and governmental systems are also changing. They are far from immune from technological developments, emerging risks, and the social uprising around them. Climate change affects the way central banks manage their inflation controls, and FinTech is changing the way transactions are made. Thus, the social, environmental, and technological developments discussed in this book have strong repercussions for the financial system and the way it operates.

As global citizens, we need to be informed about these possible risks, the ways they affect us, and the solutions to counter—and abate—them. We need to change how we invest and how we strategize our businesses. The roles of analysts and managers must be redefined, and the sooner we implement these changes, the better equipped we will be to face the transition risks and any other emerging risks that may still be coming.

Social, environmental, and technological risks are relatively new topics, but they have gained momentum recently as different books and researchers have addressed similar themes. Ackerman (2017) addresses extreme cases of climate risk and financial crises in institutions and the financial system. Aldridge (2017) describes the market microstructure and modern risks with a focus on FinTech. Taplin (2016) focuses on cyber risks in the financial sector. Tadokoro et al. (2018) discuss emerging risks from a social perspective taking the heterogeneity among different countries into consideration. Finally, the World Economic Forum (WEF 2019) provides a basic overview of today’s economic, environmental, geopolitical, societal, and technological risks. There are many other works on the topic of emerging risks, but these are arguably the most comprehensive and significant contributions related to our book.

Unlike many of the works mentioned above, our book draws on both the academic and practical worlds. The views and research exhibited in this book stem from academics and practitioners with a vast diversity of experiences. We offer a transdisciplinary approach, linking the social and natural sciences, with a specialized focus on the emerging risks affecting finance (see Fig. 1.1). We consider businesses, financial products, the stock and bond markets, as well as the global economy to offer a comprehensive and connected approach to assess new risk categories that affect each of them. Finally, we feature different countries, from Pakistan to the United States, England, and Canada, to show how emerging risks affect different societies with different ecosystems. In the end, these specific examples demonstrate that the emerging risks discussed in this book unify us on a global level.

Fig. 1.1

Emerging risks and the financial system

Our book is divided into three parts, each examining a different type of emerging risk and its associated opportunities for the financial markets.

Part I: Ecological Risks

The first part of this book contains chapters related to ecological risks and finance. In “Climate Change: Macroeconomic Impact and Implications for Monetary Policy”, Sandra Batten, Rhiannon Sowerbutts, and Misa Tanaka, from the Bank of England, address climate change–related challenges from the perspective of a central bank. Specifically, the authors highlight how climate change increases the difficulty of managing certain monetary policy objectives such as maintaining a low and stable inflation rate. They describe climate change risks as being both physical and transitional in nature, given that climate change imposes not only direct risks on various entities but also the risk associated with the current economy transitioning toward a greener one. These risks are not only felt by central banks but also by the labor market and thereby the overall economy and the financial markets.

The following chapter, “Global Warming and Extreme Weather Investment Risks” by Quintin Rayer, Peter Pfleiderer, and Karsten Haustein, explains the ways in which extreme weather events affect the financial markets. They review historical meteorological data and show that global warming has decreased the frequency but increased the intensity of hurricanes. The increased intensity causes higher disaster-related damages and liabilities for companies that operate in disaster-prone areas and ultimately affects their share price. In order to address the perceived inaction by some players, they explore why there are climate change deniers and whether these deniers may have economic incentives that drive their stance on the climate change question. They conclude that change (and the pressure to change) needs to come not only from carbon-intensive companies but also from the legal, academic, scientific, and financial community, as well as the general public.

James Leaton, a senior credit officer at Moody’s, examines climate risks from a lender’s and an investor’s perspective in his chapter “Mapping Out When and Where Climate Risk Becomes a Credit Risk”. He discusses different climate change–related risks and highlights the physical and transitional risks for various industry sectors using examples from the coal mining industry, the European utility sector, and car manufacturing. The author examines the different transmission channels that make the transitional risks felt in these industries and discusses a variety of techniques that can be used to determine the financial impact of these risks.

Martin Boyer, Michèle Breton, and Pascal François analyze the ways in which climate change, as embodied through more severe hurricanes, affects the insurance market in their chapter “Designing Insurance Against Extreme Weather Risk: The Case of HuRLOs”. Their work focuses on Hurricane Risk Landfall Options (abbreviated as HuRLOs in their title)—an investment tool that has been designed as a result of the market’s increased concern about hurricanes. These options allow investors to take positions on hurricane landfalls, thereby providing a hedging instrument against catastrophic losses. In their chapter, the authors evaluate the effectiveness of this unique hedging instrument in a realistic setting.

Chapter 6, “The Evolving Risk Management Opportunity and Thinking Sustainability First”, by Stephen Kibsey, Stéfanie D. Kibsey, Amr Addas, and Cary Krosinsky, addresses the need of defining investors’ and corporations’ fiduciary duties in the context of sustainability-oriented management and investing in order to reduce any ambiguity in their decisions. The chapter highlights the importance and necessity of ESG themes in the decision making and risk management process. It uses certain examples such as increasing talent diversity, implementing stronger cybersecurity, and transitioning to a lower-carbon economy to highlight how incorporating ESG considerations can lead to opportunities and benefits for both companies and investors.

Part II: Societal Risks

The second part and the six chapters therein relate to societal risks and how they affect our financial system. In the chapter entitled “Terrorism and Trading: Differential Equity and Bond Market Responses During Violent Elections”, Allan Dwyer and Tashfeen Hussain examine how the efficient market hypothesis applies to the emerging countries market. They use data on electoral violence in Pakistan and analyze the stock and bond market’s response to news about related terrorism events. In doing so, they also investigate country risk and the credit rating process in an emerging market such as Pakistan...

Table of contents

• Cover
• Front Matter
• 1. Emerging Risks: An Overview
• Part I. Ecological Risks
• Part II. Societal Risks
• Part III. Technological Risks
• Back Matter