Sovereign Environmental Risk

Many financial observers have begun to question the models upon which credit-rating agencies, investment firms, and others rely to price the risks tied to such securities. At the same time, it is increasingly obvious that any reform of risk models must factor in environmental implications and natural-resource scarcity.

NAIROBI – Until the global financial crisis erupted four years ago, sovereign bonds had traditionally been viewed as reliable, virtually risk-free investments. Since then, they have looked far less safe. And many observers within and outside the financial sector have begun to question the models upon which credit-rating agencies, investment firms, and others rely to price the risks tied to such securities.

At the same time, it is increasingly obvious that any reform of risk models must factor in environmental implications and natural-resource scarcity. Indeed, a recent investment report underlined that the fall in prices in the twentieth century for 33 important commodities – including aluminum, palm oil, and wheat – has been entirely offset in the decade since 2002, when commodity prices tripled.

It is likely that growing natural-resource scarcities are driving a paradigm shift, with potentially profound implications for economies – and thus for sovereign-debt risk – worldwide. Indeed, many countries are already experiencing an increase in import prices for biological resources. Financial markets can no longer overlook how ecosystems and the multitrillion-dollar services and products that they provide – ranging from water supplies, carbon storage, and timber to the healthy soils needed for crop production – underpin economic performance.

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