Ardea Investment Management (Ardea), University of Technology Sydney (UTS), and Fortlake Asset Management (Fortlake) have launched a new research paper that challenges the argument that climate change is not being factored into sovereign bond markets, bond yields and spreads.
As the world transitions towards a greener and more sustainable economy, countries are increasingly subject to climate change transition risk. However, there is a limited body of existing literature examining the impacts of physical climate change risk, particularly transition risk, and its effects on sovereign bonds yields.
Using data from 23 advanced and 16 developing markets from 2000 to 2019, the joint research paper provides an analytical framework for fund managers, investors and policy makers to assess a country’s transition risk. The analysis aligns with the UN Sustainable Development Goals (“SDGs”) – specifically, SDGs 13, 12 and 7 – carbon dioxide emissions, earnings from natural resources extraction and renewable energy consumption.
The paper’s key findings include:
Climate transition risk has two principal ways of impacting yields – directly, through risk factors, and indirectly, through macro-economic variables such as GDP. The study found that reduced carbon dioxide emissions are associated with lower sovereign borrowing costs. Meanwhile, reductions on natural resources rents in advanced countries are associated with lower sovereign bond yields and spreads.
Developing countries with high dependence on natural resources are also associated with lower sovereign borrowing costs but increases in renewable energy consumption are associated with increased sovereign borrowing costs. The study highlights that moving to clean energy is easier in advanced countries which have the capacity to borrow at lower costs, have higher GDP per capita and are more resilient to economic shocks.
Renewable energy is an economically and statistically significant mitigation strategy, as supply and consumption of clean fuel sources could drive economic growth, counteracting short-term financial losses from the non-renewable energy sector. Partnership, assistance, financial support and technology transfer from advanced countries to developing countries will therefore be critical in assisting them to successfully transition to cleaner economies.
Dr Laura Ryan, Head of Research, Ardea Investment Management, comments: “Until this report, there has been relatively little research on climate change transition risk and its impact on sovereign borrowers. Instead, existing studies have tended to focus on the physical risks of climate change.
“The evidence presented in this research paper has clear implications for policy makers, and looking into the future, governments which perform poorly in managing their climate change transition may encounter pricing or liquidity issues.
“The research finally enables governments and investors in sovereign bond markets to have a transparent and easily replicable way to evaluate climate change transition risk in relation to sovereign bond yields and spreads in the future.”
Dr Kylie-Anne Richards, Deputy CIO and Chair of ESG Fortlake Asset Management, adds: “Our paper makes the case that the risks associated with climate change are not taken seriously enough by government bond issuers and some investors. This is due to a gap in discourse around the risks that climate transition poses to government bond markets. Many issuers do not discuss these risks with their investors because of the belief that these risks are not included in the pricing. The findings of this research directly challenge this belief.
“This research gives sovereign bond market participants a clear case to request greater government transparency in specific climate risk, strategy and policy which impacts the bonds they issue.”
