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The ERISC (Environmental Risk in Sovereign Credit) methodology focuses on the development of metrics and methods for quantifying natural resource and environmental risks so they can be incorporated into country risk assessments used by insurance companies, investors and credit rating agencies.
ERISC Phase I demonstrated for the first time that natural resource-related environmental issues can affect the economic and sovereign credit risk situation of countries in ways that can be identified and quantified.
In partnership with UNEP FI and 14 leading financial institutions, Global Footprint Network examined resource trends and their economic implications for five countries.
As part of this project, we distilled the country risk profiles of Brazil, France, India, Japan and Turkey into four dimensions:
- Resource balance graded the ratio of the country’s Ecological Footprint to its biocapacity.
- Trade-related risk evaluated the country’s exposure to natural resource price volatility as well as its exposure to supply disruption.
- Degradation-related risk assessed the country’s exposure to declining productivity of its ecological assets as a result of resource overharvesting.
- Financial resilience appraised the ability of a country to respond to adverse macroeconomic shocks.
This comparative assessment was developed as a starting point for comparing risk profiles and for further exploration and development.
On Nov. 19, 2012, the key findings of the ERISC: A New Angle on Sovereign Credit Risk report were unveiled at an interactive event hosted by Bloomberg in London
The research demonstrated how importers and exporters of natural resources such as fossil fuel, timber, fish and crops are exposed to the increasing volatility that accompanies rising global resource scarcity. Meanwhile, the economic consequences of environmental degradation can be severe. For example, we estimated:
- A 10 percent variation in commodity prices is equivalent to changes in a country’s trade balance amounting to more than 0.5 percent of GDP.
- A 10 percent reduction in the productive capacity of soils and freshwater areas alone is equivalent to a reduction in the trade balance equivalent to more than 4 percent of GDP.
The methodology relied on Ecological Footprint and biocapacity metrics to assess a country’s resource risks in order to identify how they might affect sovereign credit risk. The traditional focus on renewable biological resources by Global Footprint Network (such as fisheries, forests, cropland and grazing land) was supplemented with data on non-renewable natural resources including fossil fuels, metals and minerals to provide a more comprehensive definition of natural resources.
For the figure above, the X-axis shows sovereign credit ratings (foreign currency) for five countries (source: Standard & Poor’s, 2012) and sovereign credit default swaps (source: Markit, 2012). Sources for data shown on Y-axis: A) Global Footprint Network calculations based on UNCTAD data for 2010; B) Global Footprint Network calculations.
ERISC methodology has now been applied to over 100 nations.
Towards a New Framework to Account for Environmental Risk in Sovereign Credit Risk Analysis: Co-authored by Global Footprint Network policy analyst Martin Halle, this article was one of the top three most downloaded articles in the Journal of Sustainable Finance & Investment in 2014. As a result, it is available for free download until June 30, 2015, courtesy of publisher Routledge.