From Carbon Exposure to Financial Impact, a 3D Mapping Framework for ESG Risk Assessment

The study adopts a new methodological approach to visualize and measure the financial impact of Climate Risk, by modelling it as a function of both Physical and Transition Risk (PR and TR). This is functional to test if the market is pricing climate fundamentals, or purely financial volatility remains still its focus. Starting from the most recent literature on ESG and about the risks that the firms must face on the path to the “new green” – in order to be compliant with the new, specific regulations – we define therefore financial impact z, as a function f (x, y), where x quantifies the cost cPR deriving from the increasing frequency and severity of climate related events, and their consequent structural changes, while y quantifies the cost cTR of the adjustments toward a low-carbon economy (bringing technological disruption, structural changes, policy and market shifts). We apply the analytic framework to a sample of 46 firms, chosen as the most representative global players from a full landscape of sectors, and show how chosen market-based risk measures (Value at Risk and Maximum Drawdown) respond to different combinations of cPR and cTR. We develop the model in three phases: the first one illustrating the spatial mapping of sampled firms’ environmental efficiency, the second shifting to the dynamic dimension, evaluated by mean of decoupling and efficiency measures, and the final one culminating in the spatial analysis through the which – having built TR as a function of five years financial exposure as per market priced – we evaluate vulnerability and resilience of individual firms, and generalise the approach. The analysis reveals the peculiar and unexpected behaviour of some companies, suggesting that a firm’s sustainability journey is not just a position on a ranking scale, but a trajectory influenced by internal choices and external conditions. More importantly, we prove that financial markets are still not pricing climate fundamentals. They just price pure financial volatility. All this makes experiencing the tools presented beneficial for different stakeholder’s clusters, namely: i- Investors, to the extent they allow portfolio resilience assessment and climate risk integration; ii- Firms, as far as benchmarking and transition pathways evaluation; and iii- Regulators, letting them measure and monitor systemic vulnerability and stress testing. Future research is suggested to build on the framework to explore sector-specific dynamics, policy effectiveness, or the long-term implications of divergent paths, at the same time monitoring market perception of climate risk, or how it trusts environmental scores. Keywords: Climate Risk, ESG Finance, Transition Risk, Physical Risk, Financial Stability, Response Surface Methodology, Carbon Intensity.