Climate Risks

Arjuna Dibley

Last month, a significant victory for climate change was won behind closed doors. In 2020, Katta O’Donnell, then a 23-year-old university student in Melbourne, launched a world-leading class action lawsuit against the Commonwealth government. O’Donnell alleged that she and other investors in Australian-issued bonds had been misled because the government failed to disclose how climate change might impact their investments.

Sovereign bonds allow governments to borrow money, from which, on top of taxes, they can fund expenditures and programmes. Historically, investors consider sovereign bonds issued by stable economies such as Australia a safe bet. Because our economy is large and our economic, political and legal institutions stable and mostly free from corruption, investors can be fairly certain that Australian governments will repay their debts.

This has created steady demand for Australian sovereign bonds, making them a reliable way for our governments to fund policy programmes and respond to economic shocks. But O’Donnell’s lawsuit broadly questioned whether sovereign bonds were really safe for investors once the economic impacts of climate change were taken into account. Her lawyers argued that the Commonwealth government should disclose the way climate change posed both “physical” and “transition” risks to the economy.

The first are financial risks that climate scientists say will impact Australia’s economy due to changes to the climate and the rise in extreme weather events. The second kind of risk emerges from changes in global demand for our fossil fuel exports. O’Donnell’s lawyers also suggest that investors increasingly expect governments to try to manage their climate risks.

Under the terms of the settlement, agreed on August 7 and to be approved by the court next month, the government will likely acknowledge on the Treasury website that climate change presents a risk to the country’s “economy, regions, industries, and communities”, and that there is uncertainty around the global transition to net zero emissions.

The government’s decision to disclose climate risks is no surprise. It is already taking steps to better understand and report on how climate change will affect the economy.  It has also asked some large listed companies to analyse and disclose their climate-risk exposure, and is developing a legal framework – called a “taxonomy” – to better regulate sustainable finance.

The Reserve Bank of Australia’s new governor, Michele Bullock, also said in a recent speech that the economic implications of climate change could affect the stability of the financial system. The settlement is significant because, for the first time, an AAA-rated government will recognise climate change as a systemic risk that can affect the value of its bonds. Large sovereign investors and credit-rating agencies are already focusing on how climate change impacts a country’s ability to repay, and pricing this information into its loans.

All this is creating pressure for governments like ours to better understand and disclose climate risks when they borrow money. But climate risk disclosure in sovereign bonds is not enough. Companies are more able than governments to rid themselves quickly of polluting assets, acquire new clean resources, or change the location of their operations. So while the recent case is a reminder for government issuers to consider how climate change will impact government bond repayment obligations, their challenge isn’t solved by better disclosure practices.

Moreover, under instruments such as Sustainability Linked Sovereign Bonds, governments can set climate-related performance targets, such as lowering carbon emissions by 10 per cent by 2025. These instruments create an incentive for governments to achieve real emission reductions, which is the only activity that will ultimately address climate risk in the economy.

- The Conversation