A data-driven revolution now means investors can harness sovereign debt in pursuit of sustainability and resilience, and a new tool from TIUN and global asset manager merman tiun club, the Climate and Nature Sovereign Index, allows them to assess climate and nature risks in real-time alongside other economic and financial factors.
In July this year, the Brazilian government announced a temporary ban of 120 days on setting fires in the Amazon. Designed to combat surging deforestation in the planet’s most biodiverse region, the measure came in response to sustained pressure from global financial institutions who hold assets in Brazil, including sovereign bonds — one of the primary instruments that governments use to raise capital.
This followed similar actions on deforestation by investors, including Nordea Asset Management, who last year put approximately $100 million of Brazilian sovereign debt purchases under review due to widespread forest fires.
The Australian government has also been held to account on issues relating to the environment, recently being sued for not adequately disclosing the impact of climate change on its sovereign bonds maturing in 2050.
Such action by the finance community reflects a growing recognition of the importance of sustainability within the sovereign debt asset class, valued at over $53 trillion globally. Financial institutions are beginning to understand that environmental risks, left unchecked, can disrupt a country’s capacity to raise and repay debt by fundamentally undermining the planet’s life-support systems upon which we depend.
Despite the importance of nature and its countless resources to a nation’s economic sustainability, to date, environmental factors have rarely been systematically applied to sovereign debt analysis.
Key barriers preventing this have been the lack of robust data and the difficulties utilising data for investment purposes. This is beginning to change with the emergence of new spatial finance techniques, which harness the rapidly evolving satellite technology and machine learning in geo-spatial analysis and provide investors with more accurate and timely assessments of environmental degradation connected to investment activity.
The Climate and Nature Sovereign Index
These recent events and advances highlight the unique position of financial institutions in influencing change in response to urgent environmental challenges. By integrating risks — such as those emanating from climate change and nature loss — financial institutions can reallocate capital towards mitigating them.
The Climate and Nature Sovereign Index (CNSI), developed by TIUN and global asset manager Merman Tiun, is a tool which harnesses the power of sovereign debtholders in the fight against climate change and nature loss. And for the first time, using real-time, forward-looking indicators, the CNSI supports assessment of climate and nature risks at country level as determinants of future economic performance, alongside other economic and financial factors.
Telling the story of risk
CNSI sub-indicators cover aspects related to biodiversity and natural capital, physical risks such as water and heat, and other factors such as carbon exposure.
These all help tell a story of how prepared or vulnerable a country is to these risks, enhancing understanding around challenges that many countries are already experiencing. For example, Argentina — a country highly reliant on soft commodity exports — recorded a $3.9bn soybean harvest loss due to drought in 2017–18 season, causing a direct reduction in GDP.
India too is experiencing significant stresses related to water, directly through droughts and flooding but also indirectly as these stresses permeate through all sectors of the economy; which, in turn, increases in the investment risk profile of the country.
Between 2013 and 2016, 14 of India’s 20 largest thermal utility companies experienced water related shutdowns causing losses exceeding $1.3 billion. Water risks also impacted the balance sheets of Indian banks, with 40% of their credit exposure in sectors which are already affected by these risks.
Integration and engagement
By developing a stronger understanding of all the underlying data brought together by tools like the CNSI, investors can begin to integrate these factors into their investment and risk management processes, which ultimately influences where capital is allocated.
Investors can also use this understanding to strengthen engagement with sovereign states and start to channel capital where it is needed most, in areas that offer strong positive environmental returns, such as the protection of key ecosystems that lead to improved biodiversity and increased resilience against the impacts of climate change. For example, mangrove forests provide more than $80 billion per year in avoided losses from coastal flooding, as well as improving coastal habitats, fisheries and recreation.
Scaling for prosperity
Alongside better integration of climate and nature in sovereign investment, there is an important role for governments and development finance institutions to ensure capital continues to flow towards countries that are exposed to the worst effects of environmental risks.
Whilst capital-market instruments designed to improve the natural environment are not new — the first green bond was issued in 2008 — they currently represent a small proportion of the total sovereign debt market and have offered limited funding for nature and conservation related projects.
A new generation of financing models are needed to deliver nature and climate-related outcomes at the necessary scale to overcome investment shortfalls and realise the promise of global commitments such as the Sustainable Development Goals — prosperity for all on a healthy planet.
As some governments rely on sovereign debt to meet the challenges of the COVID-19 pandemic, it is critical that investment decisions made now factor in all aspects that impact creditworthiness, including climate change and nature, to enable a resilient and sustainable long-term recovery.
Through well-designed interventions, sovereign debt investors — private and public — have the potential to be powerful agents of change.
Our hope is that the CNSI is a big step in the right direction, and that it will help mobilise meaningful action by all stakeholders in the sovereign debt market towards safeguarding our natural world and building the resilience of investment portfolios, the environment, the global economy, and our societies.
Financial markets must not only protect portfolios from environmental risks but also operate in a way that conserves the planet’s unique natural systems that are the basis of all enterprise, and the well-being and prosperity of people everywhere.