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Biodiversity

 

 

Pushing the Frontier in Environmental Analysis on Sovereign Bonds - Integrating ecological risk in sovereign credit risk models and investments

Most investors have long thought that the traditional economic indicators —and more recently, high-level environmental and political factors — were sufficient to comprehensively understand country-level competitiveness and the robustness of their economies. However, we live in an ever-more ecologically and fiscally constrained world. This is not only evident from the on-going debt crisis, but also from climate change, water scarcity, food shortages, deforestation and the many other environmental crises that we face today. Current consumption, demographic and environmental degradation patterns mean that these sorts of issues could influence the resilience of countries to deal with such changing environmental patterns in the medium to long-term. Thus, the risk frameworks that are currently being used to assess the exposure of financial products to creeping local, national and global risks must better reflect the interconnected and systemic nature of the 21st century.

The availability of natural capital for our economies is likely to increasingly become financially relevant. This can be the case not only for individual businesses, but most likely for nations as well. Natural capital can be defined as the stock of ecosystems which provides a renewable flow of goods and services such as fish, crops, timber, climate regulation and many other services. In the last few years, there have been a variety of studies that have improved the understanding of the value of ecosystem-services (such as The Economic of Ecosystems and Biodiversity, TEEB, coordinated by UNEP) as well as ecological degradation and over-use as a considerable cost to society, business and nations. For example, a study by the PRI and UNEP FI , commissioned to Trucost, measured the magnitude of global environmental externalities to be US $ 6.6 trillion in 2008, about 11 percent of the value of the global economy. The question is whether such environmental phenomena affect the financial underpinnings of sovereign fixed income investments or other types of securities. A country’s use and availability of ecosystem services plays a role in the health of its economy and its ability to secure a high quality of life for its citizens. Therefore, both the availability and use of these resources are likely to influence core economic indicators, such as its sovereign credit ratings and a nation’s ability to meet future debt obligations (positively or negatively).

Although considerable progress has been made to assess and compare the financial performance of ‘conventional’ equities with equities that embed environmental, social and governance (ESG) into financial frameworks for equity performance, to date, little progress has been made linking ESG materiality to fixed income investments, especially for sovereign bonds. This may have to do with their more ‘passive’ nature of investing. However, bonds are not shielded from systemic risks related to climate change and weather extremes, water scarcity, ecosystem degradation and availability of natural capital. At present, though, these global environmental externalities and other ESG issues are not systematically analyzed, valued or priced by capital markets).

 

Contact

 

UNEP FI:

Ivo Mulder: ivo.mulder@unep.org

Margot Hill: margot.hill@unep.org

Global Footprint Network:

Ryan van Lenning: Ryan@footprintnetwork.org

 


Related resources:
  E-RISC Brochure