This article explains S&P Global Ratings' approach to rating debt instruments that have climate resilient deferral clauses (CRDCs) and that are primarily issued by speculative-grade sovereigns, in accordance with our Ratings Definitions.

Frequently Asked Questions

What are sovereign climate resilient deferral clauses?

These clauses are used in a new type of sovereign debt that contains predefined repayment deferral features specified in the terms and conditions (T&C) of the instrument. CRDCs are specifically targeted to the most vulnerable countries, such as low- and middle-income sovereigns, that are particularly exposed to extreme climate or environment shocks. When an extreme natural disaster occurs that meets the conditions specified in advance, the sovereign issuer can temporarily suspend principal or interest payments, or both, for a preagreed period (generally, up to two years). CRDCs are expected to display cumulative deferral features--that is, when payments are suspended, the amounts are capitalized and generate further interest costs.

CRDCs are one of a range of tools that can be used to boost sovereigns' resilience to stress; strengthen the debt restructuring architecture; and, ultimately, promote sovereigns' debt sustainability. They act as temporary shock absorbers when certain sovereigns face severe nature-related events, and consequently, resource shortages. The suspension of payments temporarily releases cash that can be used to support disaster relief.

CRDCs are being actively promoted by official and bilateral lenders, some of which have already started to include them in their loan contracts. In addition, we understand that some lenders in the commercial sector are also willing to endorse CRDC clauses.

How does S&P Global Ratings rate debt instruments issued by sovereigns that contain CRDCs?

On Dec. 2, 2024, we added a new paragraph to our Rating Definitions article (see paragraph 200 of "S&P Global Ratings Definitions"). It states that, generally, if a speculative-grade sovereign meets the specific conditions listed below, the activation of a deferral clause does not cause the debt instrument to be in default, and therefore the rating on the instrument would not be lowered to 'D'.

Generally, we rate debt instruments that contain deferral clauses and that are primarily issued by speculative-grade sovereigns at the same level as the issuer. We expect to rate the debt instrument only if all the following conditions apply:

• Debt deferral on interest and/or principal is triggered by a severe natural disaster that is defined in advance in the T&C;
• An independent authority determines whether an event is of sufficient magnitude to be an eligible trigger event, as described in the T&C;
• When deferred, interest costs are fully capitalized, so that any deferral is neutral to the net present value; and
• We don't expect the issuer to selectively default on other debts.

We do not generally lower the issue rating to 'D' if a deferral occurs in accordance with the conditions above and we anticipate that payment will occur within the earlier of the stated deferral period and the original final maturity. We generally accept deferral periods of up to two years. After the deferral period, if the issuer has not repaid the CRDC as anticipated (or if, during the deferral period, we expect that the issuer is unlikely to pay), we generally lower the issue rating to 'D' and the issuer rating to 'SD'.

More specifically, in respect of the final condition listed above, CRDCs are intended to act as an effective shock absorber by enabling temporary suspension of debt service and enhancing the sovereign's overall resilience to stress. An issuer using them to prioritize certain commercial creditors over others, by activating deferrable debts and defaulting on others, would, in our view, upend the clause's intention of enhancing overall debt resilience. If this happens, we would typically lower our rating on the activated debt to 'D' and lower our rating on the issuer to 'SD/D'.

Why did S&P Global Ratings introduce such a change?

We periodically review our criteria and rating definitions and may update them, specifically when we consider that evolving trends in credit and market conditions warrant changes to ensure that our analytical frameworks remain robust and our ratings relevant.

To our knowledge, only a few countries have issued debt that includes CRDCs. These include Barbados (B-/Positive/B) and Grenada (not rated by S&P Global Ratings). Nevertheless, we expect CRDCs to gain traction in the future as private and official lenders increasingly support the inclusion of repayment deferral clauses in sovereign debt instruments. An increasing number of MLIs now include CRDC clauses in their contracts and the G20 Common Framework formally appealed for comparability of treatment with other creditors as well as for private sector involvement to ensure an equitable and comprehensive sharing of the debt relief burden. In addition, the International Capital Markets Association (ICMA) and a working group comprising bilateral, official, and private lenders are spearheading the inclusion of deferral clauses in loan agreements under specific conditions. They have published term sheet templates to that effect.

We updated our Rating Definitions to take into account both the emergence of CRDCs reserved for certain sovereign issuers and market participants' increasing acknowledgement of their merit at the low end of the rating scale.

Does S&P Global Ratings' approach apply to sovereigns only?

The approach described above applies primarily to speculative-grade sovereigns, which are the specific target for CRDCs.

Official creditors have launched numerous initiatives aimed at helping climate-vulnerable sovereigns to restore their debt sustainability and achieve long-term debt resilience (including by providing debt relief). Some representatives of private creditors are willing to build on aspects of these initiatives to develop innovative debt instruments that are also attractive to and acceptable for market participants. Our approach reflects our view that, in scope and intent, CRDC instruments are targeted at sovereigns only--specifically, low- and middle-income sovereigns that are exposed to severe climate shocks and natural disasters.

As described in our ratings definitions, the speculative-grade categories indicate vulnerability to nonpayment as issuers face major exposures to adverse business, financial, or economic conditions. When assigning speculative-grade ratings to sovereigns, we address the risks they face when exposed to recurrent extreme climate shocks and, in some cases, their limited ability to respond to those risks, among others. Conversely, assigning an investment-grade rating to a sovereign indicates that we expect it to maintain its capacity, willingness, and policy responsiveness to mitigate shocks, even extreme climate shocks, while ensuring timely repayment of debts.

We could consider applying the same approach if, contrary to our expectations, a low investment-grade sovereign were to issue debt instruments that include CRDCs. Such an issuer would most likely be a low middle-income country, such as a small island state where economic activity is highly concentrated in one sector (for example, tourism or agriculture) and would be highly disrupted by a climate shock.

Does S&P Global Ratings' approach apply only to deferral clauses linked to natural disaster events?

Yes, our approach applies exclusively to natural disaster-related events that are formally predetermined in the T&Cs of a debt instrument. We also expect CRDCs to be worded in such a way that triggering events are of a certain magnitude and that an independent authority will determine if they are eligible under the T&C.