Climate change could make borrowing more expensive
26 January 2018 | Markets
Hurricane Maria was devastating for the residents of Puerto Rico. It hurt debt investors, too. Some of the island’s bonds plunged more than 40 percent after the storm flooded the island, knocked out its electric power, and clobbered its economy.
In the U.S., costly natural disasters are becoming more common. The National Oceanic and Atmospheric Administration tallied 16 major, billion-dollar-plus storms, fires, and floods in 2017, including Maria and Hurricane Harvey, which devastated Houston. That compares with an average of about six a year since 1980. The weather and climate events wreaked a record $306.2 billion of damages, NOAA said. Companies and governments are feeling the brunt. A study in 2015 found roughly $9 trillion in rated debt exposed to environmental issues such as pollution, carbon regulation, water shortages, and natural disasters.
Lower ratings can translate into higher borrowing costs for companies, but environmental changes can also help some businesses.
Investors are pushing ratings firms to give them more of a warning about the risks. “The pressure is really mounting,” says Carmen Nuzzo, a former senior economist in London. Nuzzo is now leading a ratings project for Principles for Responsible Investment, a United Nations-backed organization that brings investors and other market participants together to talk about systematically incorporating environmental, social, and corporate governance factors into the investment process. More than 130 institutional investors—overseeing a combined $23 trillion—and 14 bond grading companies globally are participating.
In the case of natural disasters, figuring out the potential damage for individual companies and governments isn’t easy. Weather and climate are known to mathematicians as chaotic systems, which means small differences in assumptions can have huge impacts on predicted outcomes. It’s often hard to know the cost of a climate shock—and who will bear it—in part because government-backed and private insurance can mitigate losses. A Fitch review concluded in November that it is “rare” for environmental, social, and governance aspects to be the main driver of credit risk; the company says it focuses on such risks when it affects an issuer’s cash flow.
It’s clear that risks are rising, and borrowers should pay attention to them, says Rahul Ghosh, who heads environmental, social, and governance research in London. Disasters themselves can wound borrowers, but government policies concerning carbon emissions, for example, can have a big impact on them, too. “These trends will have pretty disruptive credit impacts,” Ghosh says.