FTSE Russell has unveiled the FTSE Climate Risk-Adjusted World Government Bond Index, a new fixed income index constructed using sustainability considerations.

The index tilts country weights to heighten the exposure to those that are considered more resilient to climate risks.

The index provides exposure to developed market sovereign bonds, and is the first government bond index to adjust country weights by preparedness and resilience to climate change risk.

According to FTSE Russell, the index is suitable for use as a benchmark for performance measurement or as an underlying for index-linked investment products such as ETFs.

The index is based upon the FTSE World Government Bond Index (WGBI), a widely known representation of investment-grade sovereign bonds from 22 developed economies.

The methodology incorporates a forward-looking assessment of sovereign climate risks using analysis from LSEG-owned ESG analytics firm Beyond Ratings.

Each country is assessed by three core climate risk pillars: transition risk, physical risk, and resilience.

Transition risk represents the impact on the country and its economy from the required efforts to meet the Paris Accord 2.0°Celsius target, measured on 15 variables including GDP per capita, the energy intensity of GDP, and carbon intensity of energy production.

Physical risk refers to the climate-related risk to the country and its economy from the physical effects of climate change including sea level rise, exposure of the economy to potential agricultural damages, and climate-related natural disasters such as extreme weather.

Lastly, resilience indicates a country’s preparedness and actions to cope with climate change, measured based on the strength of national institutions, and the level of social and economic development.

Countries are scored across each of the pillars and a single combined score is derived for each country. Country scores are then used to reweight the country’s exposure in the index to provide higher exposures to countries that are better prepared for climate change risks. Similarly, the methodology lowers exposure to countries that are more threatened by climate change risks.

Country climate scores are calculated annually in April with the index also maintaining the standard rebalancing processes of the WGBI.

The countries that have experienced the largest reduction in weight compared to the WGBI are the US (-3.1%), The Netherlands (-1.2%), Belgium (-0.95%), Japan (-0.5%), and Canada (-0.5%).

Conversely, the countries benefitting from greater exposure are the UK (2.5%), Germany (2.1%), Italy (1.0%), Austria (0.7%), and Spain (0.6%).

The credit rating profile of the climate risk index is broadly similar to the WGBI, though it has a slightly lower yield-to-maturity of 0.93% (vs. 1.03% for the parent index) and slightly higher duration of 8.47 years (vs. 8.31 years).

Waqas Samad, Group Director of Information Services at LSEG, FTSE Russell’s parent company, commented, “Governments are at the forefront for catalyzing and enabling the economic transition to a low carbon economy. The integration of economic and financial risk considerations linked to climate and sustainability into sovereign bond portfolios is still nascent.

“The launch of this index will allow the market, for the first time, to access a quantitative climate risk assessment for sovereign debt. Investors can now incorporate climate change risk considerations into their fixed income portfolios, and this could also inform their engagement with sovereigns. We are delighted to incorporate the expertise of the Beyond Ratings team, now as part of FTSE Russell’s extended ESG capabilities, on this ground-breaking index.”

Rodolphe Bocquet, CEO at Beyond Ratings, added, “Climate change and the efforts required to mitigate its impact carry numerous risks that have not historically been incorporated into investment-grade government debt. However, these issues have a direct and long-term impact on government finances, with projected expenditure on climate mitigation expected to reach almost $1 trillion a year for the next 30 years according to the United Nations’ Intergovernmental Panel on Climate Change. Beyond Ratings has developed a quantitative and transparent approach to climate risk modelling and assessment that will help investors mitigate these risks.”