January 26, 2021

How could climate change impact sovereign risk?

Climate risks are likely to affect the long-term investment horizon of sovereign bond investors, well beyond the general short-term perspective of financial investments. Alongside traditional fundamental sources of relative value and risk, such as the perceived health of government finances, inflation expectations and the future path of interest rates, sovereign bond investors should increasingly consider the material effects of climate change.

In this paper, we introduce what could be the impact of climate change for sovereigns via the changes in fiscal policy, social contract and political stability, in both advanced and emerging economies. First, we discuss the characterisation of climate risks, which can be divided between climate physical and transition risks. Second, we address the concern of the financial materialisation of these risks. We try to address both topics in this paper, introducing the integration of climate risks in sovereign risk assessment.