Thinking about debt, measures of financial risk, and more differential effects of climate change.

I just saw my first article linking climate change to credit ratings. The opinion came from Standard & Poor’s Marko Mrsnik and Dr. David Niklaus Bresch of the world’s largest reinsurer – Swiss Re. (http://www.iccwbo.org/News/Articles/2015/The-impact-of-climate-change-on-sovereign-ratings/).

[For those students who, like me, are early in their learning curve re. financial risk, credit ratings, and the implications of various financial indicators, here’s my cartoon version of the system:
Many nations use sovereign debt to partially finance government operations. For investors, sovereign credit ratings can signal security of investment in that nation (both directly in terms of purchasing bonds and indirectly when pursuing some sort of project in that country).
Rating agencies like Standard & Poor’s, Fitch, and Moody’s, as well as analysts at insurance organizations like Swiss Re, study how various kinds of risk impact the likelihood that debt will be repaid. Debt securities (including national sovereign bonds) are then rated (in the case of Standard & Poor’s, with a published credit rating) to signal the security’s level of risk.
That level of risk has large implications for whether and when those debt securities are attractive to investors. Standard and Poor’s ratings range from AAA: Prime, to D: In default. Ratings below BB+ are considered non-investment grade/high-yield/junk bonds.]

In their guest blog for the International Chamber of Commerce, Mrsnick and Bresch reflect on Standard and Poor’s “first-ever informed estimates on climate change’s impact on economic and individual sovereign ratings factors” using data from Swiss Re on the risks and damage data resulting from tropical cyclones and their effects (storm surges and floods).

The findings suggest “climate change will exacerbate the negative sovereign rating impact arising from 1-in-250-year natural catastrophes by 20% on average,” resulting in an average decline in sovereign ratings of 1.2 notches.

What does this mean for countries? Climate change is predicted to have highly differential effects based on both geography and income. Sovereign nations in the Caribbean and Southeast Asia are at high risk, and low-income countries are, in general, also at increased risk.

These trends correspond largely to current credit ratings (data from 2012 included below – individual ratings have changed slightly but geographic trends hold).

Standard & Poor's Credit Rating 2012

Take away: in addition to all the other environmental and human risks, those countries most at risk from the effects of climate change are also those countries most likely to have their sovereign debt further downgraded, making it harder for those nations to raise financing for infrastructure projects and attract foreign investment.

The impact of climate change on credit ratings is not as large as many other factors, including government corruption and political unrest. Still, it seems worth considering whether further integration of climate risk into measures of financial risk can be an effective way to further spur government action and to better align political and private sector interests when it comes to climate change.

One thought on “Thinking about debt, measures of financial risk, and more differential effects of climate change.

  • April 3, 2016 at 3:13 pm
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    Very interesting I never thought that there is the relationship between climate change and debt.

    Reply

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