Moody’s: Corporate disclosure will enhance carbon transition analysis
Brian Cahill, Managing Director, and Rahul Ghosh, Senior Vice President at Moody’s Investors Service
The transition to a low-carbon global economy has significant implications for global markets, with both opportunities and risks evident for the industries and companies affected.
However, assessing the effects of this transition is a complex task due to its long-term nature, the variability of potential policy measures and macro-outcomes. Meanwhile, technological innovation, company responses and the limited disclosure currently provided by many of those companies most likely to be impacted, also make it challenging to assess the implications of the transition. All of this results in a wide range of potential outcomes for affected companies.
Moody’s work in this area has focused firstly on identifying the sectors most impacted and then on developing frameworks to assess the implications for each of those sectors.
On the first point, we conducted a study in late 2015 of the relative credit exposure of 86 sectors – accounting for roughly US$68 trillion in rated debt globally – to environmental issues. This showed that while the potential credit implications vary widely by sector, the low-carbon transition risk is most likely to have material credit implications over the near term for a subset of 14 sectors with roughly US$3.2 trillion in rated debt.
Certain sectors, notably coal, coal infrastructure and unregulated power utility companies, are already seeing material credit impacts from carbon transition. For other affected sectors, including oil & gas, steel, building materials, chemicals and automobile manufacturers, the credit impact could become material over the next few years.
On the second point, we have since published a number of reports focusing on the key transmission channels for exposure at a sector level for the autos, utilities, and oil & gas industries. We are also working on similar reports for other sectors.
Comprehensive and consistent
Through such efforts, Moody’s intends to create a comprehensive and consistent way to engage with investors, issuers and market participants and to better understand and capture the credit implications of the low-carbon transition at both a sector and entity level.
As our work progresses, two issues stand out as fundamentally important to better assessing the implications of transition risk:
Firstly, greater clarity at an individual country level in respect of five, 10 and 20-year policies to reduce greenhouse gas emissions would help narrow the range of scenarios that need to be considered. The Paris Agreement has helped to improve visibility in this regard, notwithstanding the US government’s intention to withdraw from the accord. Still, governments across the world will need to translate Paris Agreement commitments into actionable policy programs in order for market participants to make informed impact assessments and investment decisions.
Secondly, analysis on this topic is challenging because of relatively weak disclosure. Company disclosures on transition risk are not consistent, transparent and comparable, and few companies provide details of the performance of their strategic plans under alternative scenarios. This makes it much more difficult to assess meaningfully the associated risks, opportunities and financial implications in a consistent manner.
Moody’s supports and has contributed to the Financial Stability Board’s Task Force on Climate-related Financial Disclosures to develop voluntary, consistent climate-related financial disclosures. The recommended disclosure standards constitute positive steps toward accurate identification of climate-related risks and opportunities. The next step could be for policymakers to promote further development and adoption of these recommendations, replicating what has been achieved with international financial reporting standards.
In short, analysing the impact of the low-carbon transition on individual companies is not an easy task. But we are committed to doing so and have increased our resources and research on this topic. Looking ahead, greater clarity on future policy direction, coupled with enhanced company disclosure of the potential effects of different transition scenarios, would provide Moody’s and other market participants with better information to help evaluate the range of potential risks and opportunities for those in the most affected sectors. In turn, this would help the efficient and accelerated deployment of capital as the world seeks to reduce greenhouse gas emissions in a manner consistent with the Paris Agreement.