Draft on Sovereign Debt
Introduction
Climate risks pose a significant threat to sovereigns, as the impacts of climate change can cause economic, social, and environmental damage to countries around the world. Climate-related hazards, such as rising temperatures, more frequent and severe natural disasters, and changing patterns of disease, can lead to a range of negative consequences, including loss of life, damage to infrastructure, reduced economic growth, and increased political instability.
The importance of Environmental, Social, and Governance (ESG) factors has become increasingly recognized in the investment community, as investment behavior and performance are closely related to ESG factors. By evaluating sovereigns based on these factors, investors can gain insights into a country's resilience to climate change, its ability to manage the risks associated with climate change, and its potential for sustainable growth.
Analysis
Based on the temperature record, global warming is an undeniable trend. Figure 1 presents an increasing tendency of the mean surface temperature change during the period 1961-2021, using temperatures between 1951 and 1980 as a baseline. In 2020, mean global temperature increased by more than 1.5°C compared with baseline. And it is projected to continue to rise. The increase in temperature is driving a range of impacts, including melting glaciers and ice sheets, rising sea levels, and more frequent and severe heatwaves. The temperature rise is also causing more extreme weather events such as flood, droughts, storm, and wildfires, which have significant implications for agriculture, water resources, and infrastructure. Figure 2 depicts the occurrences of climate-related disasters per year from 1980 to 2022. Natural disasters have occurred frequently in the recent 20 years, ranging from about 300 to 400 happening per year. Flood and storm are the most frequent ones around the world. These disasters can have long-term impacts on a country’s economy, with the costs of repairing and rebuilding often running into billions of dollars.
With continued global warming and threat from frequent climate-driven disasters, policy makers, businesses, as well as every citizen should be aware of the risks that they are exposed to and take these risks into consideration in decision-making. The map in figure 3 depicts global distribution of countries by physical risk classes using INFORM Risk Index. The darker the color is, the higher physical risk the country is facing. Some African countries as well as Afghanistan are exposed to the highest physical risks. Most countries need to bear a moderate level of physical risks, all of which require countries to develop relevant coping mechanisms so that mitigate risks and increase resilience.
ESG factors supplement traditional credit analysis and can provide information on a country’s long-term growth potential, such as social conditions and sustainability. Integrating ESG factors in investment decision-making process is important for investors in sovereign debt to achieve better investment outcomes. Expected Visualization: Higher ESG scoring sovereigns trade at growing prices and lower spreads, and generate higher returns with lower volatility.