{"id":9940,"date":"2022-09-12T12:35:51","date_gmt":"2022-09-12T12:35:51","guid":{"rendered":"https:\/\/fintech.global\/esgfintech100\/?p=9940"},"modified":"2023-03-09T11:30:59","modified_gmt":"2023-03-09T11:30:59","slug":"the-big-green-short-what-is-it-and-why-should-we-care","status":"publish","type":"post","link":"https:\/\/fintech.global\/esgfintech100\/the-big-green-short-what-is-it-and-why-should-we-care\/","title":{"rendered":"The Big Green Short \u2013 what is it and why should we care?"},"content":{"rendered":"

Globally, companies and assets are about to be revalued upwards or downwards according to their climate risk valuation. The stakes are high and the price of getting this valuation wrong could be disastrous, companies can no longer afford to kick climate risk down the road.<\/strong><\/p>\n

In a climate of constant chatter about green assets and \u2018greenwashing\u2019, Johnny Mattimore, managing director of risk and sustainable finance practice at First Derivative<\/a>, coined the phrase \u201cThe Big Green Short,\u201d to encapsulate the risk of getting valuation wrong in today\u2019s evolving market.<\/p>\n

Valuation is a zero-sum game. According to Mattimore, if you can\u2019t value something correctly, and someone else can, you will be on the losing side, every time. \u201cLet\u2019s say a bank is sitting on a trillion dollars of assets and assume those are stable and high quality. Then they do their first internal green rating, and this shows that more than 50% of their books are some of the worst polluters in the world, and they have already made a commitment to decarbonise their business 50% by 2030.\u201d<\/p>\n

Indeed, Mattimore said many banks have actually done this; made a commitment in advance of doing the detailed analysis. What\u2019s more, they can\u2019t even do the detailed analysis in the first place because the data doesn\u2019t exist.<\/p>\n

\u201cSo, the Big Green Short here is that the bank is sitting on something they think is worth 100 cents to the dollar, and tomorrow, someone who has a very similar asset is selling it at 70 in the market because they know it is going to go to 50, or 40, or 30. Then the owner holding it at 100 realises they can\u2019t access any liquidity at 100, nor now at 70, and the price starts crumbling. And they can\u2019t access any. So, they remark their position, first at 70, then at 50, 40, 30 \u2026 but they still can\u2019t sell it. So, they just keep going down, down, down.\u201d<\/p>\n

Mattimore\u2019s phrase is a play on the film \u2018The Big Short\u2019, which follows the lives of several American financial professionals who not only predicted the housing bubble crisis of 2008, but also profited from its collapse. Except this time, it\u2019s not mortgages, but green assets. \u201cThere is, however, a massive upside if you know the right price,\u201d Mattimore said.<\/p>\n

Is this happening right now?<\/strong><\/p>\n

At the moment, this is not happening on a large scale in the market just yet. Mattimore said there have only been single incidents, such as a firm being investigated for greenwashing and their share price taking a hit.<\/p>\n

However, this is because it is a \u201cyoung\u201d market. \u201cVery few people know how to actually measure whether a bond is truly green. And so far, people have taken the safe option of just saying the use of proceeds of a bond will be used for a green project. The issue is, if the bond lasts ten years, we might only find out they\u2019re a bunch of crooks in year nine,\u201d Mattimore said.<\/p>\n

If this is sounding reminiscent of the mortgage market, that is because it is remarkably similar. This is in part why the regulators are moving so quickly, Mattimore continued, they are moving fast to try to give a classification of whether or not something is green.<\/p>\n

A green company does not necessarily guarantee it is a solvent company, Mattimore was keen to point out. \u201cBeing green doesn\u2019t mean you will go up in value, you can have green assets that go bust,\u201d he said. Take, for example, a solar panel producer, who encountered real issues because the prices of raw materials have \u201cgone through the roof\u201d, and therefore they cannot maintain their profit margin.<\/p>\n

For this reason, Mattimore continued, it is important to have a modifier on when you measure a green rating on whether it is stable, improving, or deteriorating, just like you do for credit.<\/p>\n

The market is also relatively small currently. \u201cThere\u2019s about a trillion dollars of green bonds being issued, but there\u2019s probably around 300 trillion of regular bonds,\u201d Mattimore said. Yet, he stressed, this misses the point.<\/p>\n

The problem is not the greenwashing in green bonds per se, because that is a \u201cside show\u201d in some respects, Mattimore explained. Rather, the problem lies with measuring what is in your existing portfolio.<\/p>\n

Where does First Derivative come into this?<\/strong><\/p>\n

First Derivative\u2019s origins are in solving valuation problems in front office derivative trading, hence the company name. The company is now 25 years old, and Mattimore said it has been evolving in recent years. Its next phase is looking at how sustainable finance, ESG, and climate risk will affect the operating costs of financial services firms. \u201cWe are wider than just banks and brokerages firms, we do business in asset management and insurance, even doing business in areas such as aircraft leasing.\u201d<\/p>\n

Interestingly now, the shift for the different sub sectors within financial services, is they are all encountering the same data problems around sustainable finance, climate risk valuation and ESG. This is the area of focus for First Derivative.<\/p>\n

What is this data problem? Traditionally, financial data has always been in a structured format. Such as balance sheets, profit and loss statements (P&L) and cashflow forecasts. Therefore, Mattimore said if you want to do an analysis on any company in the word that you are either lending to or underwriting insurance for, or investing in, you have this ready-made information that is highly reliable.<\/p>\n

It took a long time to get to this stage however, Mattimore continued, part of that was down to technology capabilities not being as advanced in the past. Now the industry is trying to introduce non-financial data, which is typically unstructured. \u201cNot only do we have to find this data, but we have to translate it into useable economic formats, so that it looks like the type of data we have traditionally been used to.\u201d<\/p>\n

The E in ESG<\/strong><\/p>\n

The focus of non-traditional data is largely based around the Environment element of Environment, Social & Governance (ESG), although companies are looking at how to incorporate all elements<\/a> into their business and compliance programmes.<\/p>\n

For the Environment component, Mattimore said, carbon is statistically the most relevant in terms of climate change and climate risk. Although there are other factors, and indeed other greenhouse gases that could fall under the Environment umbrella, starting with the most statistically relevant will have the most impact.<\/p>\n

The regulators are also focussing their attention mainly on carbon emissions as well in terms of reporting and disclosure regulations. However, unlike most data in the past which we used for regulatory reporting, Mattimore explained this same data is going to be used in the way in which people decide to do business.<\/p>\n

\u201cSo, decision makers are going to be using this data for valuing securities, loans, and making decisions whether or not they want to do business with a company, or indeed carry on doing business with them if it turns out they aren\u2019t in great condition regarding carbon emissions.\u201d The result of this will be that the financial system will end up acting as a \u201clever\u201d in reallocating capital, from high carbon to low carbon economic activity.<\/p>\n

What about S and G?<\/strong><\/p>\n

The focus today and likely for the next 20 to 30 years, Mattimore predicts, will be on carbon emissions. Other areas within the \u2018E\u2019 component of ESG will in future include methane emissions and biodiversity measures.<\/p>\n

Turning to the social and governance components, Mattimore said these are both very underdeveloped at present. Although, there are some organisations that have been operating at the cutting edge of human population risk, he added, and Non-Government Organisations (NGOs) and disaster relief organisations do indeed have a measurement and valuation of human risk, but this has never entered the financial services industry.<\/p>\n

However, this could change in the future, as the industry begins to look for ways of adopting non-traditional factors. \u201cTraditionally, the financial services industry has never looked outside of its own origins for development of new ideas. However, in the last five years I have seen a dramatic shift of the industry beginning to look to different industries for guidance.\u201d<\/p>\n

If the industry is able to develop and adopt a robust risk framework, beginning with carbon emissions, this would better position it to follow suit with other factors. \u201cOnce you have the solid building block, it is easier to add extra components,\u201d Mattimore said.<\/p>\n

However, Mattimore emphasised that despite the way the three components have been neatly bundled together, they are not naturally compatible components, and are risk factors that are vastly different to one another.<\/p>\n

\u201cTherefore, I expect the market to start to develop internal green rating models, which actually lean on each of these [E, S and G] as key ingredients to the model. I think they will become wider and more sophisticated, in the same way credit ratings have evolved.\u201d<\/p>\n

Ultimately, Mattimore said \u201cit all comes back to pricing.\u201d If you can price an asset properly, you will fare well, \u201cbut you can only do that if you bring in metrics which are not traditional. That is what we are trying to solve at First Derivative.\u201d<\/p>\n

Read the article here<\/a>.<\/p>\n

Copyright \u00a9 2022 FinTech Global<\/p>\n

This was originally posted on FinTech Global<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

Globally, companies and assets are about to be revalued upwards or downwards according to their climate risk valuation. The stakes are high and the price of getting this valuation wrong could be disastrous, companies can no longer afford to kick climate risk down the road. 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