InsightsClimate risk moves to the fore in sovereign bond market with Australia’s precedent setting legal case

Climate risk moves to the fore in sovereign bond market with Australia’s precedent setting legal case

Bernhard Obenhuber
Jul 28, 2020

The discussion about whether the global sovereign debt market should incorporate climate risk heated up last week with a world-first legal case. The lawsuit was launched against the Australian government, accusing it of misleading investors in sovereign bonds by failing to disclose the financial risk caused by the climate crisis.

It is perhaps fitting that the first case that deals with climate change as a material risk to the global sovereign bond market is in Australia, a nation on the frontline of sovereign climate risk. Despite a strong sovereign risk rating, the country seems to almost annually be confronting the harrowing physical impact of drought and bushfires while it relies on an economy over-exposed to fossil fuels. The economic damage from the Australian bushfires at the turn of this year alone are estimated to exceed $4bn by one estimate.

The class-action lawsuit, launched by a 23-year-old law student, does not ask for damages but wants the government to step up on its climate change policies. The suit seeks an injunction stopping the government from further marketing bonds until it adds those disclosures claiming it is breaching a legal duty and deceiving investors by not informing them upfront of the climate risk they face. What makes the case particularly interesting is that the government has the power to legislate on climate change and therefore, in part, control that risk.

Mounting pressure

The pressure is now on governments to disclose their plans to measure and mitigate the risks related to climate change. The message is starting to get through. The Reserve Bank of Australia and the country’s corporate and financial regulators have warned that climate change exposes the economy and financial system to risks that will get worse if action is not taken. The bank’s financial stability review also concluded that it is becoming increasingly important for investors and institutions to actively manage carbon risk.

Australian insurers are the most directly exposed to the physical impacts of climate change and inflation-adjusted insurance claims for natural disasters this decade are more than twice what they were in the previous 10 years. Meanwhile in the US, three major storms cost the government at least $265 billion in 2017. As both the frequency and cost of extreme weather events continue to rise, governments become even more exposed to the risks related to the physical effects of climate change.

A shift in thinking

The impact of climate risk in sovereign bonds is increasingly being recognised by institutional investors. Last year, the Swedish central banksold bonds from Western Australia, Queensland and the oil-rich Canadian province of Alberta due to their failure to do more to address climate change.

But the clock is ticking on countries to disclose climate risks in their sovereign bonds. If nations fail to, more institutional investors will divest and turn their back on sovereign bonds given the reputational damage they could face if they are seen to be contributing to climate change or failing to manage climate risk.

Last September Bank of England governor Mark Carney said that the financial sector had to transform its management of climate risk, warning that global warming would prompt reassessments of the value of every single financial asset. For the longest time, it seemed as though the global sovereign debt market could keep dodging integrating climate change considerations. But now after the latest bold action from a young climate activist, this anomaly in our current financial system looks set for disruption.

Written by:
Bernhard Obenhuber