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    MFSA Assesses Impact of Carbon Taxation on Investment Portfolios

    November 15, 2021

    The Malta Financial Services Authority (MFSA) published a report on implications of the introduction of a carbon taxation on the investment portfolios of the Maltese financial system. The study focused on the climate transition risk, which could arise from the investments held in the portfolios of banks, insurance undertakings, and investment funds licensed in Malta. The research, conducted by the Financial Stability function within the MFSA, found that investment portfolios appeared, on the whole, to be resilient to carbon taxes—when assessed at six different taxation rates—although a few institutions could experience noteworthy losses.

    In all of the six scenarios, the equity asset class was impacted the most should this carbon tax be introduced, followed by Collective Investment Schemes. Bonds tended to be less affected given that a tax is expected to have a small impact on the probability of default in instruments having a short-term maturity. The authors of the report noted that taking into consideration other assets held within the financial sector, such as the loan portfolio could result in different conclusions in terms of ultimate impact from transition risk. The report highlights that the adoption of timely and adequate policy measures is crucial to mitigate climate change risks, since this could avoid having to resort to immediate and forceful interventions at a later stage, which would inevitably harm the financial system through a disruptive shift to low-carbon assets.

    The former strategy would allow market participants to perform smooth adjustments within their investment and business strategies to accommodate the changes without experiencing major losses, while the latter may trigger volatility in financial markets, possibly leading to a fire sale of carbon-intensive assets. The losses incurred in this "disorderly" scenario might be amplified in a highly interconnected system. Assessing climate risk over a short-term horizon can be used to identify the financial institutions’ resilience and vulnerabilities to climate risks. Although the short-term approach does not lead to the same comprehensive conclusions achievable under more sophisticated and long-term analyses, it indicates the level of urgency and prioritization in terms of policy intervention. Looking forward, future studies will attempt to address gaps, for example by expanding the study to include the carbon footprint of the loan portfolio of banks, delving into the companies’ trade-off between business model sustainability and absorption of any possible future carbon taxation policy. Furthermore, it would be beneficial to link this climate change analysis to possible contagion risk within the financial system. 

     

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    Keywords: Europe, Malta, Banking, Securities, Climate Change Risk, ESG, Carbon Taxation, Investment Portfolio, MFSA

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