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Credit, climate and sustainable financial system

Credit, climate and the road to a sustainable financial system

Credit markets can be pivotal for the transition to a green economy, but are already being impacted by the disruptive effects of climate change

Nick Robins
Guardian Professional, Friday 6 June 2014 12.43 BST

Credit markets are central to the global financial system. Valued at over $100tn they provide an essential way for governments, corporations and municipalities to raise bonds for public infrastructure and long-term development. Credit markets are also pivotal for the transition to a green economy – and are already being impacted by the disruptive effects of climate change.

The credit ratings agency, Standard & Poor's (S&P) has recently issued a wide-ranging set of research reports on the implications of climate change for the bonds issued by both countries and corporations. S&P's president, Neeraj Sahai, serves on the International Advisory Council of the UNEP Inquiry into the Design of a Sustainable Financial System, which aims to identify policy options to deliver a step-change in capital mobilisation for a green and inclusive economy.

S&P recently co-hosted an event with the Inquiry (disclaimer: I am a co-director of UNEP Inquiry) in New York to examine the strategic agenda linking bonds, climate change and the financial system. The event brought together leading banks, investors, public bodies and civil society organisations working to promote market and policy innovations that align finance with the green economy.

The findings of S&P's research highlight the growing materiality of climate for credit markets. According to S&P, climate change will put downward pressure on sovereign credit ratings through the 21st century, with the poorest countries bearing the brunt: all the top 20 most vulnerable nations are emerging markets. Economic output, fiscal strength and trade performance will all be hit. Corporate bonds are also being affected by extreme events and carbon risk – with the first credit downgrade for climate policy reasons occurring back in 2009. So far, climate has had limited impacts on the bonds issued by insurance companies, but this could change if the severity and frequency of extreme events intensifies.

On the upside, the bond market is also becoming a growing source of capital for the green economy – with a 50% increase in 'green bond' issuance in 2013 to $11bn, and expectations of $40-50bn in 2014. To help build integrity into this burgeoning market, a set of Green Bond Principles was issued by a coalition of 25 banks in January.

Discussions at the event highlighted that three critical issues look set to shape the way climate and other sustainability issues build tomorrow's financial system.

Climate change is a long-term risk

Climate change is a structural, long-term threat to the global economy, and one of the challenges facing both the analysts who rate the bonds and the institutional investors who buy them is how to factor in impacts outside the conventional five year window for credit ratings. Extending time horizons is central to a financial system geared to sustainability.

More information is needed

Credit markets also need deeper and more quantifiable information on climate and environmental risks more broadly. Some securities regulators have started to require corporate disclosure of environmental, social and governance (ESG) factors, but a more strategic response is required, and in the case of climate change, focusing on the twin risks of extreme events and stranded assets.

Embed sustainability - the right way

The risks revealed by the latest credit research point to the broader need for policymakers to embed sustainability factors in ways that ensure the fundamental stability of both financial institutions and financial markets. For example, climate change clearly impinges on the core task of insurance regulators to ensure that insurers are 'safe and sound'. Likewise, the rising burden of extreme events will profoundly shape the management of systemic risk, particularly in vulnerable developing countries.

In the last year, the green economy agenda has taken off in the world of credit, highlighting how quickly market forces of supply and demand can change. Yet this is only the beginning, with key steps still needed to make long-term environmental sustainability a routine part of global bond markets. But the momentum is set to grow – not least with the prospect of the UN Climate Summit in September and the finalisation of climate talks in Paris 2015.

Nick Robins is co-director of UNEP Inquiry

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