Climate risk: what is the impact on credit ratings?

Climate risk: what is the impact on credit ratings?

As climate change and severe weather events are garnering rising numbers of headlines, lenders and institutional investors are increasingly interested in how risks and opportunities associated with environmental and climate (E&C) factors figure into corporate credit ratings. Jessica Williams, the primary credit analyst on S&P Global Ratings’ recent report on the topic, explains.


In How Environmental and Climate Risks and Opportunities Factor into Global Corporate Ratings – An Update (Nov 2017), S&P Global Ratings has noted two new trends since our 2015 report: growing numbers of positive rating actions in relation to E&C influences, and increasing references to E&C factors in our analyses.
While it’s difficult to draw concrete conclusions at this stage, more positive rating actions could signal that corporates are increasingly benefitting from transition opportunities and better managing some forms of E&C risk. Meanwhile, the overall increase in references to E&C factors might indicate that E&C concerns are becoming increasingly important in terms of their impact on global corporate credit ratings.

The material impact


From mid-2015 to mid-2017, S&P Global Ratings published nearly 9,000 research updates – within which E&C risk featured a total of 717 times. Given the number of different risks that can have an impact on credit quality, this is a significant portion.

Of these 717 references, 106 listed E&C risks or opportunities as one of the key reasons for a rating action – i.e. when a rating is either raised or lowered, an outlook is revised, or when a rating is placed on CreditWatch. Notably, 41% of the 106 research updates were downgrades. However, once the ratings were grouped in to either positive or negative rating actions, the outcome became considerably more balanced.

In this report’s analysis, 44% were in the positive direction while 56% were in the negative direction – a contrast from the previous 2015 report and two-year review, in which 21% were positive and 79% were negative. This could indicate that companies are mitigating E&C risks more effectively than before, and embracing new opportunities.

The method

Measuring E&C risks and opportunities is part of S&P Global Ratings’ corporate analytical methodology. By combining various elements – such as country risk and competitive position – we can determine our credit rating for any given company. To complement this process, we also apply industry-specific criteria – commonly referred to as key credit factors (KCFs) – where E&C risk references predominantly appear.

Understandably, E&C risks feature most prominently in our criteria for the oil refining and marketing, regulated utilities, and unregulated power and gas industries – where environmental regulations and weather events tend to impact credit quality more directly. That said, E&C risks are ubiquitous across all sectors, and so they factor into our criteria for most industries.

Our assessment of management and governance acts as a modifier in our corporate rating methodology and can, therefore, influence an issuer's credit rating. Among the criteria is our assessment on a company’s ability to mitigate environmental and social risks – an important consideration given that material, unmanaged environmental and social risks can harm a company's creditworthiness over a broad time horizon.  

Climate can be difficult


It is important to note that factors extraneous to climate change may also play a role in weather events. Because of this, we consider all forms of E&C risk. We know that climate change increases both the incidence and severity of adverse weather events, such as hurricanes and droughts. However, it’s more difficult to determine whether climate change directly caused a specific weather event.

To take a recent example, there is a possibility that Hurricane Harvey might have still happened even if greenhouse gases were still at pre-industrial levels. However, scientific probability states that, if it did occur, it would most likely have been smaller in magnitude.

Ultimately, E&C factors are featuring more and more in global corporate credit ratings. Typically, E&C factors are more likely than before to constitute a positive ratings action – although the majority of updates resulting from E&C factors remain negative. So, not only are corporates potentially becoming better at managing E&C risk, but E&C concerns may also be increasingly important in terms of their impact on global corporate credit ratings.

Full report here