Rich Nations Lagging on Climate Goals May See Higher Bond Yields
(Bloomberg) -- Climate risks are already playing a key role in determining the value of government bonds, with developed nations that fall behind on green goals facing higher borrowing costs, new research shows.
Countries with reduced carbon emissions incur lower risk premiums on sovereign debt, as do developed economies willing to rely less on earnings from natural resources, according to a joint study by the University of Technology Sydney and two asset management firms. Those that boost renewable energy consumption also benefit.
In contrast, advanced economies that perform poorly in managing their climate transition may suffer increased sovereign borrowing costs, liquidity constraints and inability to finance economic recovery from severe climate shocks or natural disasters, the study shows.
Despite a surge in popularity of green finance in recent years, how to accurately evaluate and quantify the impact of climate risk factors such as carbon emissions on stocks and bonds remains a challenge for investors. This is especially so for sovereign debt, given the extra difficulties in assessing the long-term effects and costs of global warming on an entire economy.
“This research has found that climate change is a risk factor and yet issuers and governments are not talking about it,” said Laura Ryan, head of research at Ardea Investment Management Pty Ltd. “From our perspective as an investor, this is a huge oversight and it’s something that we think they should be considering.”
Ardea manages about A$23 billion ($16.6 billion) in assets and is a joint author of the research, alongside Fortlake Asset Management.
Using data from 23 advanced and 16 developing markets from 2000 to 2019, the study measures climate change transition risks by carbon dioxide emissions, earnings from natural resources extraction and renewable energy consumption. It also assesses macroeconomic indicators such as gross domestic product and inflation to work out the impact on 10-year sovereign bond yields and spreads around the globe.
Advanced countries will see a 0.26-percentage-point rise in yields for an increase of 1 percentage point in carbon emissions, while an identical gain in renewable energy consumption will cause a drop of 0.008 percentage point in yields, the study shows. If natural resources-induced profits rise by 1 percentage point, the benchmark bond yields will also rise by 0.59 percentage point.
However, the picture isn’t as clear cut for developing economies. The findings show that while yields will also rise when carbon emissions increase, they will fall when earnings from natural resources gain. Also in contrast to their developed peers, yields will also rise when renewable energy consumption increases.
The results suggest that holders of developing countries’ bonds consider the pursuit of economic growth and development via existing natural resources as a higher priority than focusing on climate change transition goals, according to the study.
The study focuses on transition risks that have an immediate impact and can shape climate policy now, said Christina Nikitopoulos, a researcher at UTS and co-author of the paper. Other studies have looked at the physical effects of climate change that take longer to be reflected in sovereign bonds, she added.
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