Climate Risk and Financial Markets: The Case of Green Derivatives

ABSTRACT:

The European financial markets have been placed on the path to a sustainable and green transition. With the EU Green Deal the European Commission embraced a new growth strategy built on a sustainable economic model that aims to make the EU the first carbon neutral continent by 2050. This generational economic and industrial transition set by the EU Green Deal will require at least 1 trillion euro in public and private sustainable investments.

This Chapter analyzes how derivatives markets can contribute to support the green transition, enable private markets to raise capital towards sustainable goals, and help market participants to manage the market and transition risk to a sustainable economy. “Green derivatives” like ESG- linked swaps, emission allowance futures, and extreme weather events derivatives are examples of how financial innovation is dealing with climate-related risk. This Chapter focuses on the EU Strategy for Financing the Transition to a Sustainable Economy in the EU and offers a look at what the Commodities Futures Trading Commission is doing in the US on climate-related risk and derivatives markets. The Chapter offers some early critical considerations on the private-public synergies and opportunities that might result from the growth and expansion of sustainable derivatives markets and the possible risks that policymakers should consider in the evolution process of such markets.