Finance for Change
Global Footprint Network helps investors, credit rating agencies and country risk analysts identify, quantify and integrate environmental risks in their decision-making.
The tightening global competition for the planet’s resources is becoming an ever more significant factor of national economic performance, yet its influence is still underestimated by most country risk analysts. With more than $40 trillion of sovereign debt in global markets at any given time, it is vitally important to understand how resource trends can affect nations' economic health and creditworthiness in the 21st century.
Do capital markets sufficiently reflect ecological risks? Are such factors reflected in the assessment of fixed-income securities? These and other questions prompted Global Footprint Network and its partners to analyze more deeply the link between resource constraints, economic performance and sovereign credit ratings.
Uncovering Ecological Risk
Environmental and resource risks are multi-faceted, interconnected and increasing in severity over time. They can impact economies in a number of ways:
- Nations are exposed to scarcity and/or price volatility of non-renewable resources such as fossil fuels, metals and minerals and renewable resources such as water, soil and biomass (food and fiber);
- Nations can experience a long-term loss of income due to the overuse and degradation of bio-productive assets such as cropland and forests;
- Climate change can affect cropland productivity and cause financial losses through drought and extreme weather events;
- A nation’s dependence on fossil fuels and use of carbon-intensive technologies can lead to stranded assets as market pressures drive a transition to a lower carbon economy.
Demonstrating the relevance of natural resource and environmental risk to a nation’s economy requires a direct and financially material linkage to be made between the extent of a country’s dependence on natural resources and its macroeconomic and fiscal performance. Our initial research into this topic, performed in collaboration with UNEP FI (United Nations Environment Programme Finance Initiative) and 14 leading financial institutions was outlined in the report ERISC: A New Angle on Sovereign Credit Risk. The report demonstrated that:
- Ecological risks are material, and many nations are exposed to resource risks to a significant degree.
- Ecological risks have different impacts on countries’ economic performance depending on their resource profile, their trade profile, the structure of their economy and their financial resilience to risk.
- These impacts are poorly reflected in current risk models.
- Environmental risks are not only a long-term concern, but can also have significant impact in the short term. In particular, food commodity price volatility can reverberate instantly on the economy of a nation with high dependence on imports.
Read more about ERISC Phase I results.
In order to further develop the ERISC method, increase its predictive power and test its in-country risk models, Global Footprint Network has partnered with UNEP FI and seven finance industry partners, including Standard & Poor’s, HSBC and European Investment Bank, in a second round of research, called ERISC II. Results are expected in the early fall 2015.
Read more about ERISC Phase II.
Investigating the Economic Impact of Stranded Assets
The concept of stranded assets has generated considerable interest in the past few years. Some analysts have estimated that up to 80 percent of fossil fuel assets (oil, gas and coal) on the books of publicly traded companies would need to remain unexploited in order to maintain temperatures below the 2-degree warming limit beyond which climate scientists predict a severe increase in catastrophic events. This represents a significant risk for investors in these companies.
But it’s not only companies that face risks due to their carbon emissions. Staying within the 2-degree warming limit will require deep and rapid changes to the economic structures of many, if not all, countries. Furthermore, a large number of national economies depend heavily on carbon-intensive sectors and economically productive assets such as factories, power plants and vehicle fleets, which are running on fossil fuels and may lose value due to their carbon intensity. This puts governments, national economies and sovereign bonds at risk. But governments that proactively address these risks will be better positioned to take advantage of the opportunities a new energy economy will present.
In the emerging field of stranded assets analysis, very little work has been completed to estimate the exposure of national economies to the loss of carbon-intensive assets. Global Footprint Network is filling this gap by proposing an assessment framework for evaluating the exposure of national economies to structural issues that could lead to asset stranding.
Our National Stranded Assets Ranking will become available later this year. We plan to distribute it broadly among the financial industry, media channels and with the general public, leading up to the climate negotiations in Paris.
Read more about our work on stranded assets.