(Bloomberg) — Investors in sovereign bonds are misbuying a growing risk that has the potential to trigger lower prices, according to a survey of analysts at Barclays Plc.
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The risk in question is countries not adequately protecting their natural capital, endangering water, air and soil resources and affecting key sectors such as agriculture, according to a group of analysts led by Maggie O’Neill, head of global ESG at Barclays. Research, wrote in a report published on Monday.
As O’Neill and her colleagues write, some of the most vulnerable markets already contain levels of waste. A default is “scheduled to trigger a sovereign default”, he said, adding that higher borrowing costs would “increase credit risk for bondholders”.
Financial markets’ disregard for natural capital has increasingly shaped regulations, with signs emerging that real-world losses pose a grave threat to societies around the world. According to Barclays research, the costs are already starting to materialize and can include everything from depleted business capital to foreclosed assets and even defaults.
Read more: Invasive species cost the global economy $423 billion annually.
Suppliers face disruptions to production and value chains, as well as fluctuating commodity prices, all of which could hurt exports and drag on banks, investors and insurers exposed to such risks, Barclays analysts wrote. They warn that the advent of biodiversity regulations has opened the door to litigation, putting bad actors at greater legal risk.
That’s why the European Securities and Markets Authority has warned that it will not tolerate misleading biodiversity claims made by investment funds. “Increasing public awareness and awareness of biodiversity threats will increase biodiversity-related financial products rapidly in number and size in the coming years,” ESMA said last week. This guarantees “increased levels of market surveillance”.
More than half of global gross domestic product is natural-based, O’Neill and her team write. “Reversing biodiversity loss is critical to limiting physical risks and avoiding significant damage to the economy,” he said.
Barkley in 2010 It estimates that by 2030 nearly $1 trillion will be needed in annual investment to protect biodiversity, compared to $160 billion currently. At the same time, there is about $725 billion spent on what Barclay calls “harmful subsidies” that harm biodiversity.
Most of the sovereign bond markets exposed to biodiversity-related financial problems are rated junk, many of which are particularly exposed to export markets, according to Barclays analysis.
Argentina, Brazil and Indonesia stand out among the G20 for their vulnerability to biodiversity. And no G20 country is more water-scarce than Saudi Arabia, according to a Barclays analysis.
Meanwhile, there are concerns that credit rating companies are not doing enough to reflect such risks. But incorporating ESG scores into credit ratings is particularly cautious, as it can affect a supplier’s borrowing costs. Even deciding how to measure and reflect such risks is controversial.
S&P Global Ratings recently abandoned an alphanumeric scale intended to capture environmental, social and governance risks associated with credit ratings, after investors found it confusing. At Moody’s Investors Service and Fitch Ratings, meanwhile, such ratings remain the norm.
At the same time, experts warn that rating companies may not be adequately monitoring ESG risks. Climate change, for example, is currently “not yet built into the system” of the three major ratings, according to Moritz Cramer, who oversaw S&P’s sovereign debt ratings until 2018 and is now head of research at LBW Bank.
In the meantime, international organizations and asset managers, including Amundi and the Principles for Responsible Investment, have created a publicly available database on the climate actions of sovereign bond issuers, which is now in the pilot phase. And international frameworks around natural capital are emerging, including the Biodiversity Accounting Financial Partnership and the Task Force on Nature-Related Financial Disclosures.
Investors can reduce their exposure to such risks by engaging with issuers, Barclays analysts wrote. Or they could opt for sovereign green bonds and debt-for-nature swaps, even though the income allocation tends to skew more toward decarbonization than nature, they say.
“Biodiversity is a productive resource that generates critical ecosystem services,” the analysts wrote. However, an asset such as value, is not systematically managed.
(A reference to ESMA is added in the sixth paragraph.)
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