Climate risks that are not assessed in the bond markets are a risk for many countries


A man uses a snow blower during a winter storm in New York on February 18, 2021.

ANGELA WEISS | AFP | Getty Images

LONDON – Climate change could see a major revival in some financial markets once investors take the risks seriously, experts told CNBC.

Debt settlement interest rates can be a reflection of how much risk there is in a particular country or company over a period of time. The higher the bond yield, the greater the risk of owning that bond and the more expensive it is for a particular company or government to raise new funding.

And there are growing concerns that today’s bond yields do not fully reflect the looming effects of climate change and related regulation on countries and businesses.

As one expert put it: Investors think of the “here and now”. This means that climate risks are not fully priced in because “right before a climate catastrophe (climate change) is a problem but a slow storm is emerging,” Marchel Alexandrovich, a senior European economist at Jefferies, told CNBC Friday.

A report by the Federal Environment Agency from 2020 found that the effects of climate change on foreign trade can have just as much impact on the German economy as the domestic risks caused by climate change. After all, Germany is Europe’s top exporter. However, German bonds are considered to be one of the safest financial assets in the world.

“I’m not sure this is fully reflected right now,” Rathbones’ fixed income director Bryn Jones told CNBC via email about climate risks. “But increasingly more. The recent downgrading of some oil companies due to climate risk by rating agencies is an indication that the risks are increasing,” he added.

This means high costs for companies, but also for countries that are heavily dependent on these reserves.

Zacharias Sautner

Professor at the Frankfurt School of Finance

The focus is increasingly on so-called green investments. Environmental, social, and corporate governance factors – known as ESG – have gained prominence in the investment community, especially after the coronavirus pandemic.

In addition, central bankers are also turning to climate change. The European Central Bank is currently examining how to “be effective in the fight against climate change”, which could lead to a change in some of its policies.

“We’d have to adequately measure what is green and what is brown, and if we push, it will have a huge impact on itself,” a member of the Financial Times’ governing council told the Financial Times earlier this month. “Brown” investments generally refer to the idea that an investment is not good for the environment.

Zacharias Sautner, a professor of finance at the Frankfurt School of Finance, told CNBC that the review of the ECB’s policies, along with the countries’ climate goals, could trigger “a full reflection of climate risks in the markets.”

More and more governments are announcing goals to become a net zero emitter in the coming decades. For example, U.S. President Joe Biden has pledged to make the country’s electricity generation carbon free by 2035 and have a net zero emissions economy by 2050. These political commitments have an impact on the way companies operate.

What a price-in could look like

“The risks for businesses are that financing costs are rising and the idea is that climate risks would either force these businesses out of business or turn into innovations that are likely to bring the globe to zero and keep financing costs at a level that means they can hold themselves as a company, “Rathbones’ Jones said Tuesday.

Forcing companies to cease operations or to change their operations significantly can result in strong market movements.

“Huge amounts of known coal, oil and gas reserves should not be used until 2050 to achieve the 2-degree target,” said Sautner via email in relation to the Paris climate agreement, in which 197 countries commit to limit had global warming to “well below” 2 degrees Celsius compared to pre-industrial levels.

“This means high costs for companies, but also for countries that are heavily dependent on these reserves because of lower taxes, higher unemployment, etc.,” he added. Overall, the companies with the highest reserves of coal, oil and gas will “have problems, but so will the countries in which they are located”.

Climate risks could therefore also lead to higher yields on government bonds.

The US, Russia, Australia, China and India are among the countries with the greatest reserves of these resources.

Could it start a debt crisis?

“I don’t think that just thinking about climate risk will trigger a crisis in the government bond market. However, there will be differences in how much individual countries are exposed to climate change and what damage they can do to trend growth or to debt / GDP ratios “said Alexandrovitch of Jefferies.

Much of the Netherlands, for example, is built below sea level, which means it can be prone to rising water levels. Climate change, along with new regulations and a change in investor attitudes, will and already have a direct impact on many nations.

According to the University of Notre Dame, the US, India, Saudi Arabia, the United Arab Emirates and Luxembourg are among the countries hardest hit by climate change when they are adjusted for their GDP.

Experts warned that if countries’ bond prices fully reflect climate risks, returns could be much higher and these countries could find it harder to balance their books.

“I do not expect a sudden debt crisis in government bonds due to climate change, but for countries that do not act there will certainly be significant effects in the next few years,” added Sautner.

“We know from research, including my own, that climate risks are increasingly being priced in in financial markets and bond markets are no exception. I believe, however, that we are not yet fully reflecting climate risks in the markets.”