SOAS University of London

New report highlights the cost of sovereign capital is significantly affected by climate risk

12 October 2020

A new report, “Climate Change and Sovereign Risk,” jointly published by the Centre for Sustainable Finance at SOAS University of London; the Asian Development Bank Institute; the World Wide Fund for Nature Singapore; and Four Twenty Seven, provides a comprehensive analysis of the ways in which climate risks affect sovereign risk.

The report demonstrates new empirical evidence of how climate risk and resilience influence the costs of capital, informing an increasingly critical conversation around the financial implications of climate change and how countries can prepare for these impacts.

Using a sample of 40 developed and emerging economies, econometric analysis shows that higher climate risk vulnerability leads to significant rises in the cost of sovereign borrowing. Premia on sovereign bond yields amount to around 275 basis points for economies highly exposed to climate risk. This risk premium is estimated at 113 basis points for emerging market economies overall, and 155 basis points for Southeast Asian economies.

The report provides a closer look at Southeast Asia, a region with significant exposure to climate hazards such as storms, floods, sea level rise, heat waves and water stress. Physical risks are expected to considerably affect economic activity, international commerce, employment, and public finances across Southeast Asian countries. Transition risks will be prominent as exports and economies become affected by international climate policies, technological change, and changing consumption patterns. The implications of climate change for macrofinancial stability and sovereign risk are likely to be material for most if not all countries in Southeast Asia.

The report highlights the need for governments to climate-proof their economies and public finances or potentially face an ever-worsening spiral of climate vulnerability and unsustainable debt burdens. It outlines five policy recommendations, emphasising the importance for financial authorities to integrate climate risk into their risk management processes and for governments to prioritize comprehensive climate vulnerability assessments and work with the financial sector to promote investment in climate adaptation.

Aladdin D. Rillo, Deputy Secretary-General of ASEAN for ASEAN Economic Community, said:
“From a macro-financial stability perspective, I would urge policy makers in Southeast Asia and elsewhere to take particular heed of the recommendations provided in this report on how to mitigate and manage climate-related sovereign risks. Without taking appropriate measures to address vulnerability to climate risks, the implications for sovereign risk can have substantial negative ramifications for financial stability, sovereign financing cost, and, indeed, economic growth. We urgently need to scale up our collective efforts to climate-proof our economies and societies.”

Dr Ulrich Volz, Director of the Centre for Sustainable Finance at SOAS University of London and lead author of the report, said:
“There is an urgent need to boost investment in climate adaptation and resilience. At the same time, governments must climate-proof their finances and debt management strategies. Central banks and supervisors will have to play crucial roles in analysing and mitigating macrofinancial risks and making sure that the financial sector is not only prepared to weather this storm, but that it also supports the economy and society in becoming more resilient to the impacts of climate change.”

Dr John Beirne, Research Fellow at the Asian Development Bank Institute, said:
“The findings in this report reinforce the urgency for national governments in Southeast Asia to tackle climate-related sovereign risks. Without appropriate action on the physical and transition effects of climate change, economies in the region will continue to incur significant premia on their cost of sovereign borrowing, threatening to undermine the sustainability of public finances.”

Emilie Mazzacurati, founder and CEO of Four Twenty Seven, said:
“Climate risk affects many aspects of a country’s economy, from agriculture to manufacturing, and will put pressure on households and public finance for disaster preparedness and investments in resilience. The report illustrates the wide range of climate impacts for Southeast Asia, one of the most heavily affected regions.”

R. Raghunathan, Chief Executive Officer of the World Wide Fund for Nature Singapore, said:
“This report provides another timely reminder of the importance of nature. Ecosystem deterioration and climate change are impacting our planet irreversibly. Central banks and financial supervisors play a vital role in addressing climate-related financial risks. This report provides appropriate recommendations that can be immediately implemented to help manage the transition to a net-zero and climate resilient future.”

Download the report.

For further information, contact:

Dr Ulrich Volz
Email:uv1@soas.ac.uk