## ch5 ## Source details **Canonical URL:** [ch5](https://www.imf.org/-/media/files/publications/gfsr/2020/october/english/ch5.pdf) ## Other formats - [Markdown version](/-/media/files/publications/gfsr/2020/october/english/ch5.pdf.md) - [Structured JSON version](/-/media/files/publications/gfsr/2020/october/english/ch5.pdf.json) --- ### Introduction - Chapter addresses two questions: - How has the COVID-19 crisis affected green financing so far? - What can be learned from past economic crises about the likely behavior of the corporate sector with respect to greening the economy? ### Short-term emissions and crisis context - Daily emissions in early April 2020 fell by about 17 percent compared with 2019 levels. - Recent studies forecast a temporary reduction in emissions of about 4 to 7 percent in 2020. - The UN Environment Programme (2019) estimates that emissions need to decline by 2.7 percent annually in order to reach the 2°C goal by 2030. - The temporary decline in emissions coincided with a temporary decline in the price of carbon emission allowances in March 2020. ### Risk of delayed transition to a low-carbon economy - Heightened economic uncertainty, a sharp drop in energy prices, and corporate balance sheet vulnerabilities may reduce investments and research in long-horizon, capital-intensive green projects. - Subsidies or economic rescue packages could slow the transition if they support firms or activities not compatible with long-term climate mitigation goals. - Alternatively, the crisis could accelerate the transition if structural shifts in consumer and investor preferences toward environmentally friendly products occur, or if beliefs about catastrophic events change (survey evidence cited). ### Green financing and investment during COVID-19 - Issuance of green corporate bonds declined in March 2020 during financial market turmoil but picked up afterward, with the share of green bonds in total corporate bond issuance returning to 2019 levels. - In the syndicated loan market, loans to firms with an above-median score in environmental performance have increased over the past decade compared with loans to firms with a below-median score; lending to both types of firms dropped slightly in the first quarter of 2020. - Investment funds focused on sustainable or environmental investments continued to attract investors throughout the crisis, with only a small drop in aggregate inflows in some asset classes. - A possible driver of strong performance for sustainable funds was relatively high returns on green investments during the crisis. - Overall assessment to date: The impact of the COVID-19 crisis on financing of green investments so far appears modest and short-lived, but significant strains on corporate balance sheets could alter this outlook. ### Lessons from past crises: financial constraints and environmental performance - Existing research suggests ESG performance of financially constrained firms is generally weaker relative to unconstrained firms. - Using multiple proxies for financial constraints (firm size, rating status, interest coverage ratio, dividend-paying status, Kaplan-Zingales index), the analysis finds: - Environmental performance falls by 10 points when firm size drops from the median to the 25th percentile of the firm size distribution. - When a firm does not pay dividends, its environmental score is 4 points lower than dividend-paying firms. - When a firm is not rated, its environmental score is 3 points lower than rated firms. - The environmental score is 1 point lower when the Kaplan-Zingales index is above the sample median. - Financially constrained firms are less likely to make environmental investments: - The probability that a firm will make an environmental investment falls by 6 percentage points when firm size drops from the median to the 25th percentile of the firm size distribution. - Similar results obtain when using firms’ carbon intensity instead of environmental performance. ### Quantitative scenarios: financial stress and output shocks - Two shocks analyzed: - (1) a global financial stress shock proxied by the Chicago Board Options Exchange Volatility Index (VIX), and - (2) a real economic activity shock capturing a sudden drop in domestic output. - VIX shock: - A sudden jump in the VIX comparable to the average level in the first half of 2020 would lead to a persistent drop in firms’ environmental performance by up to 5 points, with pre-shock performance not attained for at least three years after the shock. - The analysis uses a 16.3 point increase in the VIX (the difference in the average VIX in 2020 up to July 31, 2020, relative to the 2019 average). - The adverse effect of global financial shocks is amplified for financially constrained firms: - For firms with an interest coverage ratio below 1 or for unrated firms in 2019, the VIX shock observed thus far in 2020 is estimated to lower environmental performance by 2 additional points relative to firms with ICR above 1 or rated firms. - Output-gap shock: - A large decline in the output gap (10 percentage points, about 50 percent larger than that observed in the G7 during the global financial crisis) would lead to a 3 point decline in firms’ environmental performance in the medium term. - Firms’ carbon intensity could increase by up to 8.5 percent in the medium term after such a decline in the output gap. ### Empirical findings from output-gap shocks and oil price shocks - Contractionary economic shocks lead to lower corporate environmental performance; carbon intensity deteriorates following contractionary economic shocks. - The real economic activity shock is scaled as a 10 percentage point drop in the output gap. - Oil price shocks and environmental performance: - The effect of a decline in the international price of oil on firms’ environmental performance is ambiguous. - Lower oil prices may relax firms’ financial constraints and reduce incentives to improve energy efficiency or shift away from fossil fuels. - Lower oil prices may hurt the profitability of the oil sector, reducing fossil-fuel investments and production, and potentially easing competition for clean-energy firms. - The effect depends on the underlying source of the oil price shock (demand-driven vs supply-driven). - Econometric evidence: - Historically, when oil prices fell due to demand-side factors, environmental corporate performance has been weaker. - When oil prices declined due to an oil supply shock, environmental performance of firms has improved. - Responses at a two-year horizon are represented in the analysis. - Solid bars indicate significance at the 10 percent level. - Mechanisms and context during COVID-19: - The onset of the COVID-19 crisis was accompanied by a steep decline in the international price of oil. - Global energy demand declined by 3.8 percent in the first quarter of 2020. - The demand for oil, coal, and to a lesser extent gas and nuclear energy is projected to decline substantially by the end of 2020 (IEA 2020). - Decomposition of the oil price shock in March and April 2020 suggests it was largely driven by demand-side factors. - Implication for COVID-19: because the COVID-19-induced oil price shock is largely a demand-driven shock, firms’ environmental performance is likely to suffer. ### Econometric specification details - Panel regressions include firm-level controls: log of total assets, earnings, dividend dummy. - Additional controls: price of oil (log West Texas Intermediate), Chicago Board Options Exchange Volatility Index, country-specific output gaps. - Regressions include country and sector fixed effects. - Dashed lines in the figures represent 90 percent confidence interval. ### Climate-index evidence on corporate awareness - A firm-level climate index was constructed from quarterly earnings call transcripts using a climate change dictionary built from four climate change glossaries. - Earnings call transcripts from 4,109 firms located in 46 countries were used. - The climate change discussion index assigns a value of 1 to each earnings call transcript that contains a phrase from the dictionary (examples: “climate change,” “CO2,” “emissions”). - A sharp increase in discussions involving climate change topics is observed in 2020, coinciding with the COVID-19 pandemic. - In the earnings calls of energy sector firms, mentions of climate-change-related terms spiked after the Paris Agreement in 2016, highlighting the importance of policy risk for this sector. ### Conclusions and policy recommendations - Tighter financial constraints are associated with weaker corporate environmental performance. - Adverse global financial and output shocks that increase uncertainty and amplify firms’ financial constraints weigh significantly on environmental performance. - A reduction in oil prices against the backdrop of a decline in global economic activity is unlikely in itself to lift corporate environmental performance. - Absent strong supportive policy actions, tighter financial constraints and weaker economic activity related to the COVID-19 crisis are likely to act as a drag on firms’ environmental performance in the future. - To achieve the reduction in emissions needed to keep global warming below 2°C, an increase in green investments, in combination with steadily rising carbon prices, is critical. - Public policies and green recovery packages are important to offset potential deterioration in firms’ environmental performance resulting from the crisis. - To alleviate firms’ financial constraints and aid green investment, policies that support the sustainable finance sector are key, such as better disclosure standards, development of green taxonomies, and product standardization. *Sources: Refinitiv Datastream; and IMF staff calculations.* ### Introduction ### Introduction ### Short-term emissions and crisis context - Daily emissions in early April 2020 fell by about 17 percent compared with 2019 levels. - Recent studies forecast a temporary reduction in emissions of about 4 to 7 percent in 2020. - The UN Environment Programme (2019) estimates that emissions need to decline by 2.7 percent annually in order to reach the 2°C goal by 2030. - The temporary decline in emissions coincided with a temporary decline in the price of carbon emission allowances in March 2020. ### Risk of delayed transition to a low-carbon economy - Heightened economic uncertainty, a sharp drop in energy prices, and corporate balance sheet vulnerabilities may reduce investments and research in long-horizon, capital-intensive green projects. - Subsidies or economic rescue packages could slow the transition if they support firms or activities not compatible with long-term climate mitigation goals. - Alternatively, the crisis could accelerate the transition if structural shifts in consumer and investor preferences toward environmentally friendly products occur, or if beliefs about catastrophic events change (survey evidence cited). ### Chapter objectives - This chapter addresses two questions: - How has the COVID-19 crisis affected green financing so far? - What can be learned from past economic crises about the likely behavior of the corporate sector with respect to greening the economy? ### Green financing and investment during COVID-19 - Issuance of green corporate bonds declined in March 2020 during financial market turmoil but picked up afterward, with the share of green bonds in total corporate bond issuance returning to 2019 levels. - In the syndicated loan market, loans to firms with an above-median score in environmental performance have increased over the past decade compared with loans to firms with a below-median score; lending to both types of firms dropped slightly in the first quarter of 2020. - Investment funds focused on sustainable or environmental investments continued to attract investors throughout the crisis, with only a small drop in aggregate inflows in some asset classes. - A possible driver of strong performance for sustainable funds was relatively high returns on green investments during the crisis. ### Overall assessment to date - The impact of the COVID-19 crisis on financing of green investments so far appears modest and short-lived. - Given the severity and possible persistence of the shock—in terms of output decline, potential scarring, and heightened economic uncertainty—significant strains on corporate balance sheets could alter this outlook. - The chapter therefore examines firms’ environmental performance during previous episodes of financial and economic stress to draw implications for the current episode. ### Lessons from past crises: financial constraints and environmental performance - Existing research suggests ESG performance of financially constrained firms is generally weaker relative to unconstrained firms. - Using multiple proxies for financial constraints (firm size, rating status, interest coverage ratio, dividend-paying status, Kaplan-Zingales index), the analysis finds: - Environmental performance falls by 10 points when firm size drops from the median to the 25th percentile of the firm size distribution. - When a firm does not pay dividends, its environmental score is 4 points lower than dividend-paying firms. - When a firm is not rated, its environmental score is 3 points lower than rated firms. - The environmental score is 1 point lower when the Kaplan-Zingales index is above the sample median. - Financially constrained firms are less likely to make environmental investments: - The probability that a firm will make an environmental investment falls by 6 percentage points when firm size drops from the median to the 25th percentile of the firm size distribution. - Similar results obtain when using firms’ carbon intensity instead of environmental performance. ### Quantitative scenarios: financial stress and output shocks - Two shocks analyzed: (1) a global financial stress shock proxied by the Chicago Board Options Exchange Volatility Index (VIX), and (2) a real economic activity shock capturing a sudden drop in domestic output. - A sudden jump in the VIX comparable to the average level in the first half of 2020 would lead to: - A persistent drop in firms’ environmental performance by up to 5 points, with pre-shock performance not attained for at least three years after the shock. - The analysis uses a 16.3 point increase in the VIX (the difference in the average VIX in 2020 up to July 31, 2020, relative to the 2019 average). - The adverse effect of global financial shocks is amplified for financially constrained firms: - For firms with an interest coverage ratio below 1 or for unrated firms in 2019, the VIX shock observed thus far in 2020 is estimated to lower environmental performance by 2 additional points relative to firms with ICR above 1 or rated firms. - A large decline in the output gap (10 percentage points, about 50 percent larger than that observed in the G7 during the global financial crisis) would lead to: - A 3 point decline in firms’ environmental performance in the medium term. - Firms’ carbon intensity could increase by up to 8.5 percent in the medium term after such a decline in the output gap. *Source: Chapter 5 — Introduction, Global Financial Stability Report: Bridge to Recovery (October 2020).* ### 1. Response of Environmental Score (y-axis) over Time (x-axis) to a ### ch5 - 1. Response of Environmental Score (y-axis) over Time (x-axis) to a ### Empirical findings from output-gap shocks - Contractionary economic shocks lead to lower corporate environmental performance; carbon intensity deteriorates following contractionary economic shocks. - The real economic activity shock is scaled as a 10 percentage point drop in the output gap. - Dashed lines in the figures represent 90 percent confidence interval. - Econometric controls include: log of total assets, earnings, a dividend dummy variable, the price of oil (log West Texas Intermediate), the Chicago Board Options Exchange Volatility Index, and country and sector fixed effects. ### Oil price shocks and environmental performance - The effect of a decline in the international price of oil on firms’ environmental performance is ambiguous: - Lower oil prices may relax firms’ financial constraints and reduce incentives to improve energy efficiency or shift away from fossil fuels. - Lower oil prices may hurt the profitability of the oil sector, reducing fossil-fuel investments and production, and potentially easing competition for clean-energy firms. - The effect depends on the underlying source of the oil price shock (demand-driven vs supply-driven). - Econometric evidence: - Historically, when oil prices fell due to demand-side factors, environmental corporate performance has been weaker. - When oil prices declined due to an oil supply shock, environmental performance of firms has improved. - Responses at a two-year horizon are represented in the analysis. - Solid bars indicate significance at the 10 percent level. ### Mechanisms and context during COVID-19 - The onset of the COVID-19 crisis was accompanied by a steep decline in the international price of oil. - Global energy demand declined by 3.8 percent in the first quarter of 2020. - The demand for oil, coal, and to a lesser extent gas and nuclear energy is projected to decline substantially by the end of 2020 (IEA 2020). - Decomposition of the oil price shock in March and April 2020 suggests it was largely driven by demand-side factors. - Implication for COVID-19: because the COVID-19-induced oil price shock is largely a demand-driven shock, firms’ environmental performance is likely to suffer. ### Econometric specification details - Panel regressions include firm-level controls: log of total assets, earnings, dividend dummy. - Additional controls: price of oil (log West Texas Intermediate), Chicago Board Options Exchange Volatility Index, country-specific output gaps. - Regressions include country and sector fixed effects. - The real economic activity shock is scaled as a 10 percentage point drop in the output gap for panels 1 and 2. ### Climate-index evidence on corporate awareness - A firm-level climate index was constructed from quarterly earnings call transcripts using a climate change dictionary built from four climate change glossaries. - Earnings call transcripts from 4,109 firms located in 46 countries were used. - The climate change discussion index assigns a value of 1 to each earnings call transcript that contains a phrase from the dictionary (examples: “climate change,” “CO2,” “emissions”). - A sharp increase in discussions involving climate change topics is observed in 2020, coinciding with the COVID-19 pandemic. - In the earnings calls of energy sector firms, mentions of climate-change-related terms spiked after the Paris Agreement in 2016, highlighting the importance of policy risk for this sector. ### Conclusions and policy recommendations - Tighter financial constraints are associated with weaker corporate environmental performance. - Adverse global financial and output shocks that increase uncertainty and amplify firms’ financial constraints weigh significantly on environmental performance. - A reduction in oil prices against the backdrop of a decline in global economic activity is unlikely in itself to lift corporate environmental performance. - Absent strong supportive policy actions, tighter financial constraints and weaker economic activity related to the COVID-19 crisis are likely to act as a drag on firms’ environmental performance in the future. - To achieve the reduction in emissions needed to keep global warming below 2°C, an increase in green investments, in combination with steadily rising carbon prices, is critical. - Public policies and green recovery packages are important to offset potential deterioration in firms’ environmental performance resulting from the crisis. - To alleviate firms’ financial constraints and aid green investment, policies that support the sustainable finance sector are key, such as better disclosure standards, development of green taxonomies, and product standardization. *Sources: Refinitiv Datastream; and IMF staff calculations.* --- _Source: https://www.imf.org/-/media/files/publications/gfsr/2020/october/english/ch5.pdf_