Climate change and its effect on sovereign risk

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A new report, “Climate Change and Sovereign Risk,” jointly published by the Centre for Sustainable Finance at SOAS University of London; the Asian Development Bank Institute; the World Wide Fund for Nature Singapore; and Four Twenty Seven, provides a comprehensive analysis of the ways in which climate risks affect sovereign risk.

The report demonstrates new empirical evidence of how climate risk and resilience influence the costs of capital, informing an increasingly critical conversation around the financial implications of climate change and how countries can prepare for these impacts.

Using a sample of 40 developed and emerging economies, econometric analysis shows that higher climate risk vulnerability leads to significant rises in the cost of sovereign borrowing.

Premia on sovereign bond yields amount to around 275 basis points for economies highly exposed to climate risk. This risk premium is estimated at 113 basis points for emerging market economies overall, and 155 basis points for Southeast Asian economies.

The report provides a closer look at Southeast Asia, a region with significant exposure to climate hazards such as storms, floods, sea-level rise, heatwaves, and water stress.

Physical risks are expected to considerably affect economic activity, international commerce, employment, and public finances across Southeast Asian countries.

Transition risks will be prominent as exports and economies become affected by international climate policies, technological change, and changing consumption patterns.

The implications of climate change for macrofinancial stability and sovereign risk are likely to be material for most if not all countries in Southeast Asia.

The report highlights the need for governments to climate-proof their economies and public finances or potentially face an ever-worsening spiral of climate vulnerability and unsustainable debt burdens.

It outlines five policy recommendations, emphasising the importance for financial authorities to integrate climate risk into their risk management processes and for governments to prioritize comprehensive climate vulnerability assessments and work with the financial sector to promote investment in climate adaptation.

Aladdin D. Rillo, Deputy Secretary-General of ASEAN for ASEAN Economic Community, said:

“From a macro-financial stability perspective, I would urge policymakers in Southeast Asia and elsewhere to take particular heed of the recommendations provided in this report on how to mitigate and manage climate-related sovereign risks.

Without taking appropriate measures to address vulnerability to climate risks, the implications for sovereign risk can have substantial negative ramifications for financial stability, sovereign financing cost, and, indeed, economic growth. We urgently need to scale up our collective efforts to climate-proof our economies and societies.”

Dr. Ulrich Volz, Director of the Centre for Sustainable Finance at SOAS University of London and lead author of the report, said:

“There is an urgent need to boost investment in climate adaptation and resilience. At the same time, governments must climate-proof their finances and debt management strategies.

Central banks and supervisors will have to play crucial roles in analysing and mitigating macro-financial risks and making sure that the financial sector is not only prepared to weather this storm but that it also supports the economy and society in becoming more resilient to the impacts of climate change”.

Dr. John Beirne, Research Fellow at the Asian Development Bank Institute, said:

“The findings in this report reinforce the urgency for national governments in Southeast Asia to tackle climate-related sovereign risks.

Without appropriate action on the physical and transition effects of climate change, economies in the region will continue to incur significant premia on their cost of sovereign borrowing, threatening to undermine the sustainability of public finances.”

Emilie Mazzacurati, Founder and CEO of Four Twenty Seven, said:

“Climate risk affects many aspects of a country’s economy, from agriculture to manufacturing, and will put pressure on households and public finance for disaster preparedness and investments in resilience.

The report illustrates the wide range of climate impacts for Southeast Asia, one of the most heavily affected regions.”

R. Raghunathan, Chief Executive Officer of the World Wide Fund for Nature Singapore, said:

“This report provides another timely reminder of the importance of nature. Ecosystem deterioration and climate change are impacting our planet irreversibly.

Central banks and financial supervisors play a vital role in addressing climate-related financial risks. This report provides appropriate recommendations that can be immediately implemented to help manage the transition to a net-zero and climate-resilient future.”

The full report and executive summary are attached to this email (under embargo until Monday 12 October). The report will also be available to download from Monday.

The report is jointly published by the Centre for Sustainable Finance at SOAS University of London; the Asian Development Bank Institute; the World Wide Fund for Nature Singapore; and Four Twenty Seven. The research was supported by INSPIRE, a global research stakeholder of the Central Banks and Supervisors Network for Greening the Financial System (NGFS).

Launch event

The report launch event, “Climate Change and Sovereign Risk” will take place on Zoom on Monday 12 October at 9-11 am Washington DC / 2-4 pm London. Please register ahead of attendance.

Taking place in conjunction with the International Monetary Fund/World Bank Group 2020 Annual Meetings, this virtual event will highlight the key findings of a new policy report by SOAS University of London, Asian Development Bank Institute, WWF, and Four Twenty Seven on the impacts of climate-related physical and transition risks on sovereign credit risk and debt sustainability, as well as the public policy and financial governance implications.

The discussion will focus on the channels through which climate-related risks can affect sovereign risk and the importance of their respective impacts.

It will also examine the implications for the management of public finances, the challenges facing financial supervisors and central banks, and how international financial institutions can support countries in mitigating related risks and fostering resilience.

Presentation of main takeaways from a new report on “Climate Change and Sovereign Risk”

  • Ulrich Volz, Director, SOAS Centre for Sustainable Finance, SOAS University of London & Senior
  • Research Fellow, German Development Institute
  • John Beirne, Research Fellow, Asian Development Bank Institute

Panel discussion

    • Shamshad Akhtar, Chair of the Board of Directors, Karandaaz Pakistan
    • Ekhosuehi Iyahen, Secretary-General, Insurance Development Forum
    • Emilie Mazzacurati, Founder and CEO, Four Twenty Seven
    • Nick Robins, Professor in Practice for Sustainable Finance, LSE
    • Ahmed M. Saeed, Vice President for East Asia, Southeast Asia, and the Pacific, Asian Development Bank
    • Mark Thomas, Director of Country Credit Risk, World Bank

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