The biggest risks on the horizon to sovereign solvency, such as climate and demographic change, are not cyclical.
Credit rating agencies’ ‘long-term’ sovereign ratings supposedly
reflect credit risk up to ten years. That time horizon is designed to
assess fundamental risks through an economic cycle. But the biggest
risks on the horizon to sovereign solvency, such as climate and
demographic change, are not cyclical. They are structural. And they are
long-term. The risks are plainly more elevated as we move out the yield
curve.
The time has come to make long-term ratings truly long-term.
Investors deserve a more reliable measure of sovereign credit risks
beyond the next few years. One solution would be a regulatory
requirement for agencies to issue ‘truly-long-term’ sovereign ratings,
distinct from their current so-called ‘long-term ratings’. Failing to do
so would bar them from rating government bonds above a certain initial
maturity, e.g., 10 years.
The Financial Stability Board (FSB) should provide the required
leadership to bring about this change. Through its prior work on
climate-related financial disclosure, the FSB has the competency and the
credibility to shift the debate. Changes like the introduction of
truly-long-term ratings could take years until full implementation. In
the meantime, the unmeasured credit risks will mount inexorably.
full paper
© CEPS - Centre for European Policy Studies
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