The Climate Conundrum: Risk and Opportunity? Post-webinar Q&A

Read some key climate credit risk questions submitted by the audience during The Climate Conundrum: Risk and Opportunity? Post-webinar Q&A.

Need to assess the impact of climate risk on your financials?

1. What is climate risk?
   Climate-related risk refers to the potential negative impacts of climate change on an organization. The risks are primarily divided into two categories: (1) Physical risks, which arise from changes in weather and the climate that can impact corporate assets around the world and economies, and (2) Transition risks, which arise from the costs associated with the move to a low-carbon economy.
2. Can you provide some numbers as to how many banks and insurance customers are using S&P Climate Credit Analytics (CCA) stress testing models for their regulatory exercises and/or TCFD reporting?
   We are unable to share exact numbers but have customers across the globe (including in Japan, Europe, and the U.S.) who have subscribed to the solution for these types of use cases. This also spans industry segments and, in addition to banks, insurers and asset managers are utilizing the models.
3. Can you suggest a few case studies for banks that want to work on climate impact risk assessments for their portfolios?
   The banks that we have worked with usually choose the top 10-15 exposures that are from high-carbon emitting sectors for the purpose of case studies. This can vary from region to region. For banks in Europe, for example, case studies may focus on the auto segment which is an important area for the region. For banks in Australia, they may focus on the mining segment.
4. Considering the cost of exploration of sustainable sources of energy and the subsequent cost of production, don't you think the energy transition would lead to inflation globally?
   It is hard to say. A major and sudden technological breakthrough (e.g., nuclear fusion reactors) to produce “clean and free” energy could lead to a collapse of energy prices. How this could ripple in the real economy is a very complex topic that will be influenced by many factors, including central banks’ monetary policy, governments’ economic and fiscal policy and external shocks (e.g., the COVID-19 pandemic).
5. Do we need extra licenses to access the data?
   The models utilize a variety of underlying data, including company financials, industry data, variables from the Network for Greening the Financial System (NGFS) scenarios that are relevant to specific sector models and environmental data. Most of this data is included with a license for the offering itself, except for environmental data where an additional license is needed.
6. How can I effectively incorporate climate risks into credit risk assessments?
   There is no historical experience on what an energy transition may entail, partly because this is the first-time governments are embarking on such a process, and because there is a lot of uncertainty about how to balance transition risks and opportunities with the speed of the transition itself. The best practice is to analyze the financial impact of an energy transition, leveraging multiple realistic scenarios and granular data to account for company-level nuances and industry-level characteristics. Our solution combines granular data at a company and industry level with the financial expertise of Oliver Wyman[1] and our modeling expertise in credit risk. CCA incorporates scenarios adopted by various financial regulators across the world for stress testing purposes that are quickly becoming the standard in this field.
7. In the small government (city/county) and higher education sectors that do not have public ratings, how would you incorporate the impact of climate risk into the credit analysis?
   The analysis uses granular assumptions and derived data based on a company’s own financial standing, industry segment data and the country’s policies and green trajectory to determine the impact of climate risk on the credit analysis of entities where the data may not be available at the entity level. These are well-accepted factors that can play a significant role in determining the impact when such information is not available.
8. Should lenders/investors be taking account of firms’ emissions when allocating capital?
   This is very important. In fact, one should not just look at firms’ current emissions, but also projected emissions, investments companies will make to bring these down, and how fast a carbon tax will penalize emissions. Through our research and tools, we find a significant financial impact at the company level, and this translates into a credit risk impact, too.
9. When you conduct a stress test by applying some form of carbon tax/price, do you incorporate companies' ability to pass through such costs to customers? I am primarily thinking about U.S. regulated utilities operating in a cost-of-service regime.
   Yes, incorporating the pass-through of costs is critical to capturing the actual business dynamics. Our solution does consider this aspect in detail for all sectors being covered, not just for regulated utilities.