Biodiversity loss, decline of ecosystem services, and overall environmental degradation can hit economies through multiple channels. The combined macroeconomic consequences can impact sovereign creditworthiness. Yet, the methodologies published and applied by leading credit rating agencies (CRAs) do not explicitly incorporate biodiversity and nature-related risks.
Omitting them may ultimately undermine market stability. As environmental pressures intensify, the gap between the information conveyed by ratings and real-world risk exposure may grow. A consistent approach to integrating nature- and biodiversity related risks into debt markets is long overdue.
This report models the effect of nature loss on credit ratings, default probabilities, and the cost of borrowing. The results have implications for stakeholders including credit rating agencies, investors, and sovereigns themselves.
1. Implications for credit ratings agencies
i) Biodiversity- and nature-related risks can have significant impacts on sovereign creditworthiness,
default probability, and the cost of capital. Environmental macroeconomic models are increasingly able to describe direct economic consequences of nature and ecosystem service loss.
ii) Credit rating agencies can and should incorporate nature-related risks into rating methodologies. As environmental pressures mount and the potential economic consequences become more severe, the gap between the risks incorporated in ratings and those faced in the real world will grow.
2. Implications for investors
i) Ratings that ignore biodiversity loss are omitting a significant source of risk. Investors who rely on nature-blind measures of creditworthiness will be unable to correctly identify, price, and manage risk across their portfolio.
ii) Backward-looking risk assessments are insufficient. Whilst it is important to acknowledge that nature loss and climate change have already begun to impact the cost of borrowing for some sovereigns, investors should apply forward-looking risk metrics that address forthcoming risks based on the best possible science.
3. Implications for governments
i) Economies with high dependence on ecosystem services face a choice: pay now, by investing in nature, or pay later through reduced fiscal space and higher borrowing costs. The ‘pay now’ option generates long-term returns for people, business, and nature. The ‘pay later’ option entails significant downside risks, with little to no upside.
ii) This is not just a story for financiers and finance ministries. It is not only the financiers that lose out when ecological damages affect the creditworthiness of nations but also ordinary people who need to make payments on their mortgages every month that will be affected once interest rates go up.
iii) There is a strong economic rationale to sovereigns themselves to take action to reverse the trend in nature decline. Economies that maintain or enhance natural capital could in principle see their creditworthiness improved, as depletions elsewhere make their natural assets scarcer and more valuable.