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.