In 2014, George Osborne made headlines as he announced the UK government’s intention to redeem bonds stretching back as far as the eighteenth century. This included First World War debt, as well as bonds issued during the South Sea Bubble crisis (1720) and the Napoleonic wars (1803-1815).1
The human interest element of the story is surely what caught the public’s attention. But it serves to emphasise two important, if somewhat elementary, points:
Even if we meet the Paris target and keep global warming well below 2˚C – which is looking increasingly unlikely – it is hard to imagine a world where climate change doesn’t cause significant economic disruption. How different will sovereign creditworthiness look by 2050?
A recent report from the Intergovernmental Panel on Climate Change (IPCC) finds that ‘some vulnerable regions, including small islands and Least Developed Countries (LDCs), are projected to experience high multiple interrelated climate risks, even at global warming of 1.5°C'.2
Our first chart, based on projections from the Swiss Re Institute, suggests that global temperature rises will negatively impact GDP in all regions by 2050, with the losses increasing significantly as the temperature scenarios ramp up.
Swiss Re Institute. Temperature increases are from pre-industrial times to mid-century and relate to increasing emissions and/or increasing climate sensitivity (reaction of temperatures to emissions), from left to right.
The implications for sovereign financial stability could be extreme. However, no sovereign issuer has yet been downgraded on account of climate risk.3 In other words, ratings have some catch-up work to do.
A landmark report issued by the University of Cambridge in 2021 finds evidence that these downgrades will begin ‘as early as 2030, increasing in intensity and across more countries over the century’.4
Our next two charts are taken from this report. They highlight the regions that are likely to be worst affected by ratings changes.
Bennett Institute, University of Cambridge (2021).
*Report refers to an RCP 2.6 scenario. RCPs are Representative Concentration Pathways and describe different potential scenarios under future emissions trends. RCP 2.6 is the ‘stringent climate policy’ scenario and is most consistent with limiting warming to below 2°C.
Source: Bennett Institute, University of Cambridge (2021).
*Report refers to an RCP 8.5 scenario. RCPs are Representative Concentration Pathways and describe different potential scenarios under future emissions trends. RCP 8.5 is the high emissions scenario and is most consistent with a 5°C warming world.
The evidence suggests that it is time for ratings to catch up. But Moritz Kraemer, a former Chief Ratings Officer at S&P Global, has argued that ratings methodologies aren’t currently compatible with long-term structural changes like global warming:
The agencies’ “long-term” ratings supposedly reflect credit risk up to 10 years. That time horizon is designed to assess fundamental risks through an economic cycle. But the changes to our climate and demographics are not cyclical. They are structural. And they are long-term.⁵
The challenge for investors, then, is ensuring that their research and risk assessments take stock of the credit risk posed by climate disruption. They will have to go further than ratings providers if they want to build resilient portfolios.
Invesco’s active fixed income teams carry out detailed credit analysis before investing, incorporating ESG considerations into their analysis. This allows them to form a comprehensive understanding of the issuer, its risks, and the potential opportunities.
Using data from organisations like the UN, the World Bank and the International Energy Agency, they score sovereign issuers on 23 indicators. Seven of these are environmental, with three focused on climate change specifically.
In this way, they aim to provide impartial insights on the key risks impacting sovereign debt securities today.
We know investors are living through an unprecedented period of market disruption and volatility. As we face these new realities, we think taking an unfixed approach to fixed income is an advantage.
From active to passive, from mainstream to innovative, we have the expertise, the strategies and the flexibility needed to match your objectives as markets evolve.
Having set ambitious national climate targets, the UK has been largely content to follow the EU’s lead regarding the Green Taxonomy, but there are divergences. Unlike the Europeans, British policymakers have put nuclear and hydrogen at the centre of their plans. There is further divergence at both the corporate and investment product levels.
The UK is leading the charge against climate change and has already made huge improvements compared to many of the world's largest polluters. With an economy focused on service industries, the UK’s carbon intensity has fallen over the last decade, and the government has announced various measures to accelerate the transition to net zero.
The value of investments and any income will fluctuate. This may partly be the result of exchange rate fluctuations. Investors may not get back the full amount invested.
All data is provided as at the dates shown, sourced from Invesco unless otherwise stated.
This is marketing material and not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.
Where individuals or the business have expressed opinions, they are based on current market conditions. They may differ from those of other investment professionals. They are subject to change without notice and are not to be construed as investment advice.
