Climate policy and financial system stability: evidence from Chinese fund markets

ABSTRACT

The impacts of climate policies on the global financial system have aroused wide attention all over the world. Fund markets are an important part of the financial system and play a crucial role in the stability of the financial system. In this paper, the impacts of climate policies on fund markets are evaluated from direct and indirect risk contagion channels using the data of Chinese ordinary stock funds and partial stock hybrid funds during 2007–2020. Risk contagion indicates that a fund's selling of stocks causes the stock price to fall, causing asset losses to other funds holding the same stocks. We construct a risk contagion model based on common asset holdings of funds. The analysis of direct risk exposure of funds to climate policy in China shows that five climate-policy-relevant sectors account for more than half of the total value of shareholdings. The climate risk stress-test indicates that ignoring the indirect risk contagion channel significantly underestimates the adverse effects of and climate policies on fund markets. More stringent, short-term climate targets and earlier implementation of climate policies helps to mitigate otherwise drastic changes required in energy markets in China to achieve a 2°C long-term target, and reduces the adverse effects of climate policies on the fund market. Furthermore, the impact of climate policies on different investment funds shows significant differences, leading to winners and losers. The losers are funds that adopt a high-carbon investment strategy, while winners are funds adopting a green investment strategy.

Key policy insights

• Indirect risk contagion significantly increases the adverse effects of climate policies on investment fund markets.

• Early implementation of climate policy and more stringent short-term targets reduce the adverse effects of climate policies on the fund market.

• Investment funds can become winners by adopting green investment strategies with the introduction of climate policy.

KEYWORDS:

• Climate policies
• fund markets
• common asset holdings
• climate risk stress-test

Disclosure statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been corrected with minor changes. These changes do not impact the academic content of the article.

Notes

1 Fund markets indicate all open-end funds in this paper.

2 The fund's net asset ratio indicates the ratio of total assets to the net assets of the fund.

3 Summary statistics of shocks under different scenarios may be found in the Supplementary Material.

Additional information

Funding

This research is supported by The Fundamental Research Funds for the Central Universities (2242022S20019) and the Fundamental Research Funds for the Central Universities and Scientific Research Foundation of Graduate School of Southeast University (YBPY2146).