Climate risks negatively influence credit quality at just 4% of companies

Reflects the difficulty of estimating a net economic loss ahead of a climate physical risk event


Pierre Georges, global head of ESG credit, S&P Global Ratings

While climate transition and physical risks are important considerations in our credit analysis, we have taken few climate-related actions on our rated nonfinancial corporates since 2022.

The IPCC has reported on the climate urgency and the UN has relayed the need to limit global warming to well below 2°C, but this has so far not translated into radical and immediate changes to industrial plans or economic models.

But this may change, particularly if net-zero momentum accelerates and leads to more-abrupt regulatory changes, requiring companies to fast-track low-carbon investments, or if companies fail to adapt to heightened climate physical risks.

Climate transition risks can be classified around four pillars: regulation (the most relevant to a company’s credit standing), technology, litigation (which is increasing but manageable) and consumer behavior.

Some investors will check to see if companies are backing their words with actions, particularly on climate. Also, companies and investors’ lobbying activities will come under scrutiny ensuring consistency with public commitments to both sustainability and fiduciary mandates.

Lack of policy action

This absence of disruptive action could also explain the few credit rating actions related to the climate transition.

Carbon pricing has been limited in scope and has had little impact on credit performance. There are currently relatively few carbon-pricing regulations, covering less than one quarter of global GHG emissions. While we see some mounting pressures, we have not taken any negative rating actions related to this more stringent carbon regulation.

The Inflation Reduction Act (IRA) is another recent significant policy development. It aims to support investments in decarbonization solutions and may help grow new technologies.

Certain segments in the power, autos, midstream utilities, agribusiness, and healthcare sectors could see marginal positive credit impacts from improved cash flows and reduced development and technology costs for renewables and carbon capture. That said, we have not taken any rating actions as a result of the IRA because related credit improvements will take time to materialize.

The way forward

Despite the low number of climate-related rating actions, climate transition risk and physical risk could become significant ESG credit factors that affect the creditworthiness of rated entities.

This is because of policymakers’ efforts to reduce emissions or ensure greenhouse gas emissions reflect their full social costs, and because of the potentially increased impacts from more frequent and extreme weather events.

Climate regulations and policies will continue to evolve, but likely similarly to how they do today–in an uncoordinated and often unpredictable manner across sectors and regions. This may require more granular surveillance within sectors as we assess the credit effects of sometimes diverging regional regulations.

Significant incentives worldwide to develop new environmentally friendly technologies and production processes could also result in greater rating differentiation over time. Entities’ ability to access capital is another area of focus, as pledges and regulations can rapidly evolve and lead to credit underperformance. Infrastructure, scale, scope, and diversification can be key mitigants, and location matters.

Climate physical risks could have significant financial implications for some assets in certain jurisdictions, if and when such risks materialize. But where and when physical risks might crystallize and cause economic loss is inherently unpredictable, as are the frequency and severity and how risks and costs might be mitigated.

This is the main reason why climate physical risks have negatively influenced the credit quality of only about 4% of nonfinancial corporates, or about 170 rated entities. This limited overall net credit influence on our rated universe reflects the inherent difficulty of estimating a net economic loss ahead of a climate physical risk event, which are mostly unpredictable. It also reflects that many corporates have a fair degree of diversification of their operating assets and can potentially divert supply chains through alternative channels to avoid material operating disruptions.

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