Sovereigns and ESG
Sovereigns exposed to climate risks should value the importance of ESG
Author
Jingning Feng
Executive Summary
Climate change pose significant risks to sovereigns, including rising temperatures and more frequent natural disasters.
Sovereigns around the world all face different levels of climate-related risks, which require them to build resilient economies and mitigate risks.
There is a positive relationship between sustainability and economic development, encouraging sovereigns as well as invesotrs to consider ESG factors in decision-making.
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. Figure 4 indicates how resilient countries are in face of climate-related risks. Higher-income countries tend to have higher resilience, while lower-income countries tend to have lower resilience. It makes sense because higher-income countries have more financial resources and human capital to tackle the consequences of potential risks. In addition, higher-income countries are able to invest more resources in new technology and clean energy development, which can accelerate the transition to low-carbon economy. Figure 5 confirms this fact again, showing that the top ten countries in the sustainability index are all from the high-income group, and nine of them are European countries.
The sustainable competitiveness of a country can impact the country’s financial performance and economic development. Figure 6 shows a weak but notable positive relationship between sustainable competitiveness score and FDI inflows based on the data in recent two years. European countries, with higher sustainability scores, are generally attracting more FDI than other regions of the world. Figure 7 reveals a evident positive relationship between sustainability score and GDP per capita. Countries with higher levels of economic development may be better positioned to invest in sustainable development and environmental protection. Improved sustainability can lead to further economic growth by mitigating the climate-related risks. Therefore, sovereigns that prioritize sustainability and value ESG factors can benefit from increased investor confidence, improved access to capital, reduced risks, and long-term economic and social development.
Conclusion
In conclusion, evaluating climate risks and considering ESG factors is essential for sovereigns to build resilient economies, promote sustainable development, and mitigate the risks associated with climate change and other sustainability challenges. Moreover, by prioritizing ESG factors, sovereigns can improve their access to capital and increase their competitiveness in a rapidly changing world. Therefore, it is important for sovereigns to include ESG factors in their policies and decision-making processes to ensure long-term economic and social prosperity.
References
European Commission. “INFORM Risk Facts & Figures.” DRMKC, 2023. https://drmkc.jrc.ec.europa.eu/inform-index/INFORM-Risk/Risk-Facts-Figures.
Lindsey, Rebecca, and Luann Dahlman. “Climate Change: Global Temperature | NOAA Climate.gov.” Climate.gov, January 18, 2023. http://www.climate.gov/news-features/understanding-climate/climate-change-global-temperature.
SolAbility Sustainable Intelligence. “ESG-Adjusted Country Ratings Better Reflect Investor Risks & Opportunities.” SOLABILITY, November 2022. https://solability.com/the-global-sustainable-competitiveness-index/sovereign-bonds-sustainability.