Sovereign bond risk: the climate punch

Wednesday, 23 September 2023

This month a world-first court case saw a national government accused of misleading investors by failing to disclose the financial risk caused by climate change, and specifically, the risk to sovereign bonds.

It is the first, and only, legal action in the world that seeks to hold a sovereign nation accountable for not disclosing the risks of climate change to sovereign bond investors.

However, it may not be the last.

The class action, launched in 2020 by a young Australian university student, made the following allegations:

  1. physical and transition risks from climate change are material risks for bond holders;
  1. transition risks will be exacerbated the longer the country (in this case Australia) takes to commit to a net zero emissions target and the longer it takes to implement effective measures to reach net zero;
  1. not disclosing climate change risks to bond investors is misleading or deceptive in law (12DA of the Australian Securities and Investments Commission Act 2001 (Cth)).

The result? The Australian government chose to settle rather than proceed to court. As part of the settlement, it agreed to publish a statement on a Treasury website acknowledging that climate change was a systemic risk that may affect bond value.

What’s the significance?  

This case  carries two clear messages for the international finance sector and governments globally.

  • The market is now looking at potential impacts of climate risk on sovereign bonds. Physical climate risk analysts including XDI and FTSE Russell are already providing investors with sovereign and sub-sovereign intelligence.
  • In a world where climate change litigation is growing and where the financial and reputational impact of cases can be substantial (read NGFS’s new report on climate litigation) acknowledging and quantifying sovereign risk is increasingly critical.

Climate exacerbated extreme weather events around the globe are already materially impacting government spending, and their cost and frequency are on the rise. Sovereign and sub-sovereign bond health is closely tied to the health of the economies they’re attached to.

So what countries are safe to invest in? What sovereign bonds (a nominally low risk investment vehicle) will be safe to invest in years to come? XDI (Cross Dependency Initiative) has some insights to share for investors to further understand physical climate risk to the built environment, globally.

Earlier this year, XDI (Cross Dependency Initiative) published a global ranking, the XDI  Gross Domestic Climate Risk, calculating physical climate risk to the built environment in over 2,600 states and provinces around the world. It also identified which of these jurisdictions see the greatest escalation of modelled damage from 1990 to 2050.

The results exposed the engine rooms of the global economy as being among the states and provinces most at risk.

  • Two of China’s largest sub-national economies – Jiangsu and Shandong – top the global ranking, in first and second place. Over half of the provinces in the global top 50 are in China.
  • After China, the US has the most high-risk states with 18 states in the top 100. Florida is the highest-ranking US state, followed by California and Texas.
  • Together, China, India and the US make up over half the states and provinces in the top 100.
  • Other highly-developed and globally-significant economic hubs in the top 100 include Buenos Aires, São Paolo, Jakarta, Beijing, Hồ Chí Minh City, Taiwan and Mumbai.
  • Australia, Belgium, Italy, Canada and Germany also have states and provinces in the top 100.
  • South East Asia experiences the greatest escalation in damage from 1990 to 2050 anywhere in the world.

The findings of the XDI Gross Domestic Climate Risk underscore the importance of pricing physical climate risk in sovereign and  sub-sovereign bond markets, given the amount of capital investment represented by the assets at risk in the states identified, the vulnerability of global supply chains, and the need for climate resilience to inform investment.

To help investors understand and manage this risk, XDI has launched the Global Domestic Climate Risk platform.

The interactive, online  tool provides an asset-level bottom up analysis of more than 2600 states and provinces using over 320 million data points.  Contact our team to learn more.

A note of caution: some governments may try to persuade bond buyers that their commitments to adaptation will mitigate the risk to their bonds, however it may be wise to approach this with a dose of scepticism. Many of the mitigation and adaptation measures required to reduce material risk are heavily dependent on government policy. Rather ironically, some of the states most at risk are also those opposing regulation of greenhouse gas emissions, and are reluctant to invest in solutions.



Petrana Lorenz, Director of Communications: +61 405 158 636