Incorporating Climate Risks and Opportunities: Insights from a leading Credit Agency

As part of the Wheeler Institute Climate Initiative, Lucrezia Reichlin, London Business School Professor of Economics and trustee of the International Financial Reporting Standards (IFRS) Foundation, recently hosted a webinar on “The need for and impact of high quality globally comparable reporting” on 10th March 2022. Lucrezia was joined by Richard Cantor, Chief Risk Officer of Moody’s Corporation, and was moderated by Shivangi Kumra, an MBA 2023 candidate at the London Business School

The Role of Credit Agencies in the green revolution

Mr. Cantor described Moody’s as an “integrated risk assessment company” which deals with many different risk factors. The biggest segment of Moody’s focuses on credit ratings and related research that reflect the risk of loss and default on debt securities, which covers hundreds of trillions of dollars of global debt. As for the risks relating to the climate and the carbon transition, these can heavily affect ratings. Moody’s assesses how these climate risk factors can affect financial securities. Mr. Cantor mentioned that “double materiality” is an angle of risk that involves the risk of climate change and its effects on society, and that risk ultimately does affect financial securities.

The change of investor Sentiments to fuel climate action

Mr. Cantor mentioned how Moody’s is monitoring the decline in investors’ willingness to lend to or invest in companies that are not meeting expectations with their operational efforts to curtail climate change. Mr. Cantor stated that if investors begin to withdraw from investing in these types of companies, those companies’ access to funding would decrease and the cost of the funding that they do secure would increase. One-third of global assets are currently tied to ESG metrics, which is a growing trend and quickly becoming the norm. Although investors demand adequate returns for their investment, more than ever they are also seeking companies who are are earning those returns while transforming their ESG footprint. Credit agencies continue to cautiously monitor this phenomenon while adapting to these emerging and developing investor demands.

How rating agencies handle the transition risk of energy companies.

Mr. Cantor mentioned how rating agencies such as Moody’s have been on a journey to increase transparency as to how carbon transition risks affect credit ratings. This includes publishing methodology as well as providing profiling entities metrics around carbon transition risks. Moody’s has a specialised group dedicated to climate change and has trained over 1,500 analysts when it comes to climate considerations. A lot of the climate issues are currently uncertain when it comes to the total impact of emissions, but the focus is on assessing the impact of ESG considerations on an entity’s credit risk. Most companies’ ratings are affected negatively, due to the cost of transition, however, an increasing amount of companies are positively impacted. For high-emitting sectors, Moody’s tackles risk assessment with a two-pronged approach. The first is strictly data-oriented and focuses on the key metrics that well describe their current climate position, a medium 3–5-year horizon focusing on secular change, and metrics looking at the long-term projections. These yield an objective score that is assessed by analysts who then provide an internal adjusted score to reflect the qualitative views of the analysts.

Moody’s handles emerging market companies the same way. Most of them are trying to access global financing and have the same level of disclosures as to their analogs in developed countries. Mr. Cantor mentioned however, that Moody’s has local rating entities in some emerging markets and focuses on green and other specialised forms of financing for their local markets.

How sovereign entities are affected

Mr. Cantor stated that the consideration involves a couple more factors when it comes to assessing sovereign credit risk. The effects of large-scale changes such as those arising from higher water levels and similar climate-induced problems are considered. There are also many sovereign entities that derive a significant amount of revenue from the fossil fuel industry and exports. Some of the risks faced by those economies are very significant and their credit ratings are lower because of it. However, some entities with “deep pockets” are less affected. There’s a lot of advocation on behalf of emerging markets from international organizations such as the G20. There needs to be more action taken by countries beyond advocation to meet goals that have been set for carbon reduction and the energy transition. The uncertainty around carbon transition is of major concern to potential creditors which is making the situation a bit more difficult, and it seems that a near-term transition is not what is being priced into the market. A portion of the transition away from oil and gas has also been caused by oversupply in the market rather than the underlying fundamentals of the green energy space.

The importance of shared data for proper risk calculation

Professor Reichlin pointed out how currently there seems to be a “jungle of data providers” who aren’t very keen on sharing data with public institutions and key stakeholders in the form of a common repository, which would make proper risk assessment much easier to measure. Mr. Cantor stated that this currently is the case, and this will likely improve in the future as private companies start to gather and share more of that data. The economics of selling that data for fees isn’t very large and that will likely prompt and encourage the many different data providers to make that data publicly available and will immensely facilitate the risk assessment process.

Conclusion

Credit agencies serve a vital role in supporting and cementing the the adoption of ESG requirements of investors, and directly influence investors’ sentiments about lending to and investing in companies. The analysis and research these credit agencies conduct are even more important in emerging markets where information may be scarce and scattered. The rating agencies and other research institutions are trailblazing the methodology for assessing and incorporating the effects of ESG initiatives and climate change into credit analysis. There’s a good reason for credit agencies to be cautious and consistent in their approach to assessing different companies as well as different investor markets, however individual nuances must also be taken into consideration. It seems that credit agencies are attempting to cautiously navigate incorporating these new investor behaviors and requirements and are taking a proactive approach to understanding and analyzing how climate change and ESG initiatives affect credit analysis.

About Moody’s

Moody’s is a global integrated risk assessment company and operates one of the world’s major credit rating agencies, as well as operates Moody’s Analytics which focuses on investor services and economic research. Moody’s has over 14,000 spread out across more than 40 countries to cover global markets and economic developments.

About Richard Cantor

Mr. Richard Cantor serves as Chief Risk Officer for Moody’s Corporation (MCO) and Chief Credit Officer for Moody’s Investors Service (MIS). He manages the Credit Strategy and Standards Group, which is responsible for the credit rating agency’s global credit strategy and thematic research, the quality and consistency of its ratings across regions and sectors, and the procedures, methodologies, models, and tools used in the determination of ratings. Prior to joining Moody’s in 1997 he held a variety of positions at the Federal Reserve Bank of New York and was an adjunct professor at NYU’s and Columbia University’s business schools.


Hadi Hussaini, CFA (MBA 2023) has four years of experience in asset management working at The TCW Group and Morgan Stanley. He is now a PR & Communications officer of the London Business School Student Administration and an intern at the Wheeler Institute focused on content generation to drive workforce inclusivity and sustainable development in the Middle East and Africa. 

The Wheeler Institute Climate Initiative seeks to understand, illuminate, and support the business community – individuals and systems – in understanding, responding and adapting to the challenges and opportunities that climate change presents. We have a particular interest on implications and actions for those in developing countries.

Professor Reichlin’s conversation with Richard Cantor is the final event in a five-part webinar series with high-profile corporate leaders that aims to explore how public and private institutional investors can restructure capital offerings and risk management processes to reflect climate forces.

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