Roughly 27% of issuers of investment-grade debt in both the U.S. and Europe could incur costs that exceed one-quarter of the market value of their debt if policymakers act to limit global temperature rise to 1.5°C or from physical climate risk, according to the analysis, which examined data from 1,039 investment-grade issuers, as of June 30, 2021.

The spread that investors demand for issuer-specific risk could increase by 234%, to 301 basis points (bps), for U.S. investment-grade debt and grow nearly five-fold, to 416 bps, for investment-grade debt in Europe in a 1.5°C scenario, the analysis finds.

Though uncertainty about the future asset value of a firm tends to result in a widening of its credit spread, neither credit spreads nor the cost of debt financing have yet to reflect either the risk of a transition to a greener economy or threats of extreme weather, according to the analysis.

Share of fixed-income universe at risk of extreme costs related to climate change

Proportion of issuers and market value where the cost of climate change, from policy risk and aggressive physical risk, aggregated at the company level is more than 25% of the total current market value, under the two global temperature-rise scenarios, 1.5°C and a 3°C, as of June 30, 2021. Proportions calculated within the issuer universe with available climate-cost data.

Still, it challenges the view among many bondholders that shareholders will absorb the costs of climate change and that the time horizon for climate policies to impact the asset value of firms is well beyond the maturity of most bonds.

“Our result suggests that the risk for bond portfolios is material and uncertainties about the climate policies and the path only add to the downside risk to corporate-bond portfolios,” write MSCI’s Afsaneh Mastouri, Rohit Mendiratta and Guido Giese, the co-authors of the study.


How climate risk could change the spread of corporate bonds

Market-value weighted-average current issuer spreads and spreads after including the cost of climate change from policy risk and aggressive physical risk under the two global temperature-rise scenarios, 1.5°C and 3°C. To capture nonlinear effect of asset value loss on corporate bond spreads, we have applied a cap of 10% on OAS spread of investment-grade issuers and 30% on OAS spread of high-yield issuers, including climate change cost. Data as of June 30, 2021.

Climate risk could sweep more broadly in the high-yield market, where 38% of issuers in both the U.S. and Europe could incur extreme costs in a 1.5°C scenario. Spreads could follow suit. The spread on U.S. high-yield debt could increase nearly 300%, to 1060 bps, and for high-yield debt in Europe by 327%, to 1061 bps, in that scenario.

The risk for issuers would diminish with policies designed to limit temperature rise to 3°C. Roughly 9% of investment-grade issuers in the U.S. and 8% in Europe could incur extreme costs from either policy or physical risk in a 3°C scenario. Spreads on investment-grade debt would grow by 131% and 213% in the U.S. and Europe, respectively.

Continue reading

In Transition to a New Economy Corporate Bonds and Climate Change Risk. Climate-change risk could negatively affect corporate-bond portfolios, an analysis by MSCI shows.

Foundations of Climate Investing: How Equity Markets Have Priced Climate-Transition Risks. Climate-transition risk impacted the price of stocks during the study period, after controlling for traditional equity style factors, an analysis by MSCI finds.

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