By Waqas Samad, Group Director of Information Services, LSEG
Bond markets are three times larger than equity markets, so it’s surprising that while sustainable equity investment strategies have caught the imagination of investors across the globe, they have so far less successfully ignited fixed income investing.
This may be about to change. According to the United Nations’ Intergovernmental Panel on Climate Change, climate mitigation costs for governments are estimated to reach almost $1 trillion a year for the next 30 years. This should surely be concerning for investors because climate change—and the efforts required to mitigate its impact—carry numerous risks that have not historically been incorporated into investment grade government debt investment decisions.
Governments will be at the forefront of reducing the impact of climate change on the economy, corporations and people, so investors increasingly need to be able to model climate risk into their sovereign fixed income exposure. So I’m excited to see that our teams are launching the first climate risk government bond index today: The FTSE Climate Risk-Adjusted World Government Bond Index allows sovereign debt investors to incorporate climate change risk considerations into their portfolios.
The index methodology incorporates three important elements:
- transition risk - the impact on the country and its economy from efforts to meet the Paris 2.0 degree Celsius target
- physical risk - the climate related risk to the country and its economy from the physical effects of climate change including sea level rise and climate related natural disasters
- resilience - a country’s preparedness and actions to cope with climate change.
It will be fascinating to see the long-term impact of greater awareness of the impact of climate change on sovereign debt. According to a new study of credit default swap spreads on sovereign bonds by Hermes, and our new colleagues at Beyond Ratings, countries that perform well on environmental, social and governance metrics are viewed by investors as less likely to default.
Nearly 20 years ago we launched the FTSE4Good Index Series—a family of ethical investment stock market indexes. Those indexes were at the forefront of a new wave, a precursor to the revolution in sustainable equity investment and it feels like these fixed income indexes are at the beginning of the next chapter on fixed income.
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