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Canada is more susceptible to climate-change risk than many other developed nations, creating risks for investors who buy federal government bonds, according to a leading provider of investment data.

FTSE Russell, a subsidiary of the London Stock Exchange, has created the FTSE Climate Risk-Adjusted World Government Bond Index, which weights government debt from 22 developed nations based on what it perceives as the economic risks of climate change in each country.

FTSE Russell says the index allows investors to “engage” with countries on their climate risk, predicting that bond yields of best performers “will decrease as they attract more investors’ demand,” according to its promotional materials.

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An institutional investor using the index to adjust its debt portfolio could sell off debt from countries with greater climate risk and buy more debt from countries with less risk. And that, in turn, could make it easier for a country with less climate risk to issue debt at lower interest rates.

In the initial composition of the climate index, calculated in July, Canada’s debt was underweighted by nearly half a percentage point – enough to put it in the top five countries for underweightings, or when a portfolio has less of a stock or bond than a benchmark suggests.

Canada isn’t at as much physical risk from climate change as other countries, FTSE Russell estimates. But it ranks near the bottom in what it considers “transition risk" – the challenges in reducing emissions in the long term, as well as “resiliency,” a broad set of indicators, including economic and social factors.

It is, says Marina Mets, the managing director of product management at FTSE Russell Canada, “a mixed risk profile.”

So far, investors’ focus on climate risk has mostly been applied to individual stocks, particularly in the energy sector. But increasingly, investors are asking all companies to assess and disclose how climate risk applies to them. Extending climate analysis to government bonds is a step further, and one that many investors seem prepared to take.

James Davis, chief investment officer at OPSEU Pension Trust, said it is a natural progression for climate-change risk research to turn to sovereign debt markets.

“Investors are gaining more and more interest in climate change, climate-change risk and understanding it," he said. “The disclosure around it and the transparency around it is going to be essential. Climate-change risk is very much a macro risk. ... I know that interest rates and bond yields are going to be driven by expectations around economic growth and expectations around inflation."

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The International Monetary Fund is examining the impact of climate on the world’s financial markets and whether it is priced into market valuations, the head of the global lender’s markets division told Reuters.

Paul Bowes, head of FTSE Russell Canada, said that in terms of interest in climate change, asset managers and pension funds in Canada are much more active than in the United States.

"In Canada we’re more like Europeans – it’s a topic in an area that people are desperate to know more about. … We’re getting better engagement here in Canada than in other markets.”

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