AIFMRM publishes world-class research in response to global crises
By Associate Professor David Taylor
Industries around the world are grappling to come to terms with the consequences of global conflict and violence, climate change, escalating natural disasters, and a consequential increase in market volatility. Researchers at AIFMRM have responded by engaging with industry leaders, applying their minds, and collaborating with peers from across the globe to contribute solutions to the challenges the financial industry is facing.
Climate change and the resulting higher temperatures in the atmosphere and oceans are causing an increase in natural disasters around the world. In 2023, the US saw a record $23-billion of losses due to climate disasters in the form of hurricanes, floods and wildfires. In East Africa, floods and droughts wreak havoc on lives and communities. “As a researcher, I want to be a part of the solution,” says Andrea Macrina, Professor of Mathematics at University College London (UCL) and Adjunct Professor at the African Institute of Financial Markets and Risk Management (AIFMRM), UCT. “Climate change affects all of us, and we should be part of the solution, to inform the debate and explore what we can do from our particular field of knowledge.”
Professor Macrina has been collaborating with industry experts and academic peers on research to develop ways for banks and financial institutions to drive sustainable finance solutions that may combat the impact of climate change. In 2023, with Chris Kenyon from MUFG Securities and Mourad Berrahoui from Lloyds Banking Group, he published two papers on the carbon equivalence principle and methods for project finance in Risk.net. Another research article on pricing the transition of Scope 3 emissions has recently appeared.
The implications of this research are far-reaching. The Net-Zero Banking Alliance (NZBA), whose members represent 41% of global banking assets, has committed to net-zero carbon in their portfolio impacts by 2050. Implementing this commitment has proven difficult. Professor Macrina’s research presents methods for valuing financial portfolios based on the mitigation cost (benefit) of CO2-equivalent emissions that financial products enable. The researchers priced the cost-benefit of transitioning carbon externalities into changes affecting deals won and lost to steer the portfolios to net zero based on a CO2-equivalent valuation adjustment.
“Our research helps to make a start in challenging the understanding of how carbon emissions liability is accounted for on the books of the bank and to see the levels of risk. Exploring the carbon footprint of a bank in its operation is deeply relevant to the sustainable finance field,” says Professor Macrina, who recently travelled to South Africa to give talks at universities and industry workshops.
Earlier in 2023, AIFMRM researchers also published a highly-regarded article in the prestigious Journal of Mathematical Finance on how variants in a capital structure modelling approach of stock-based loans can have a marked significance when it comes to pay-outs for shareholders. One of the study authors, AIFMRM Adjunct Associate Professor Tom McWalter, explained that their paper looked at how variants in a capital structure modelling approach of stock-based loans can have a marked significance when it comes to pay-outs for shareholders.
This may sound technical, but the principles underpinning this research have direct implications for all companies and institutions in the financial sector. The financial crisis that saw three banks fail in the US in March 2023 and caused major problems at Credit Suisse in Switzerland raised specific questions around financial modelling and risk management and where weaknesses may occur in financial structures.
The research of AIFMRM’s Adjunct Associate Professor Tom McWalter, Honorary Professor Peter Ritchken and Dr Alex Backwell provides financial companies with an accurate and optimal way to finance themselves or to distribute their capital. It also relates to conflicts of interest for those who provide or control the funds. Their research examines the difference between buybacks and paying dividends to shareholders and yields greater transparency as to the benefits of each. Ordinary shareholders, who may be company employees, need to know if there is a conflict of interest in the way company earnings are distributed. By identifying such conflicts, shareholders can be assured that their interests are not overlooked in favour of fund managers or other role players.
Ultimately, these researchers are adding to the conversation and are contributing to the solution to financial crises. “Hopefully, it will spur other academics on to pick up where we left off,” adds Dr Backwell. This is, in many ways, the crux of the matter. Professor Macrina, AIFMRM’s new lead researcher, explains that academic input is vital to advance knowledge in a particular field of industry research. It may take years of work to produce a measurable impact on practices in the real-world setting.
“Industry research and development is empowered by academic expertise, and it is very important to foster collaboration between universities and the industry,” he says in conclusion. “AIFMRM has a research focus with a gaze on what is happening globally but also what is relevant to South Africa and the African context, so it is excellently positioned to participate on the world stage when it comes to the latest advances in mathematical finance research.”
Associate Professor David Taylor is the founding director of the African Institute of Financial Markets and Risk Management at the University of Cape Town.