Nature loss and sovereign credit ratings

Matthew Agarwala, Matt Burke, Patrycja Klusak, Moritz Kraemer and Ulrich Volz

No 2024-09, Accountancy, Economics, and Finance Working Papers from Heriot-Watt University, Department of Accountancy, Economics, and Finance

Abstract: Biodiversity loss and environmental degradation can hit economies through multiple channels. The combined macroeconomic consequences can impact sovereign creditworthiness. Yet, the methodologies published and applied by leading credit rating agencies (CRAs) do not explicitly incorporate biodiversity and nature-related risks. Omitting them may ultimately undermine market stability. As environmental pressures intensify, the gap between the information conveyed by ratings and real-world risk exposure may grow. A consistent approach to integrating nature- and biodiversity-related risks into debt markets is long overdue. Conceptually, incorporating biodiversity- and nature-related risks into sovereign ratings is no different from including other difficult to quantify risks - such as geopolitical risk or contingent liabilities - that are already embedded in ratings methods. A common excuse for excluding biodiversity and nature-related risks is that the scientific uncertainty is allegedly too high. However, that uncertainty is not fundamentally different from the uncertainties surrounding issues of geopolitical risks or contingent liabilities. The omission of nature risks in sovereign assessments is no small matter. According to World Bank estimates, the cost of national GDP loss following a partial collapse of ecosystem services would exceed the GDP loss caused in 2020 by the Covid-19 pandemic in around half the countries for which data is available. While a pandemic is impossible to predict for rating agencies, the risk of biodiversity loss can be more precisely quantified and geographically localised. Given the potential size of the related economic risk for individual sovereigns, the inclusion of nature risks into sovereign risk frameworks is not only expedient, but inevitable. (...)

Keywords: Sovereign credit rating; nature loss; counterfactual analysis; general equilibrium model; corporate debt; sovereign debt (search for similar items in EconPapers)
JEL-codes: C15 G32 H63 Q54 Q57 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:hwuaef:302571

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