Using Scenarios to Evaluate the Medium to Long Term Impact of Transition and Physical Climate Risks on Credit Quality

This blog is written and published by S&P Global Market Intelligence, a division independent from S&P Global Ratings. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence credit scores from the credit ratings issued by S&P Global Ratings.

Given the extended time horizons to evaluate the implications of climate change, pricing long-term customer and supplier relationships correctly requires the use of suitable medium- and long-term scenarios that capture the capital investments needed to reduce polluting emissions, pay higher carbon taxes and mitigate the asset depreciation or damages caused by physical events, such as hurricanes and wildfires. Together, these factors can have a profound impact on customers and suppliers profitability and credit risk.

S&P Global Market Intelligence (Market Intelligence”) in collaboration with Oliver Wyman^[1] developed Climate Credit Analytics (CCA) to assess the implications of energy transition scenarios at individual company and portfolio levels, for multiple sectors.^[2] CCA is a suite of quantitative tools that combine Market Intelligence's extensive data and analytical resources — including company financials, industry and market data and credit scoring methodologies — with Oliver Wyman's leading climate scenarios and stress-testing expertise.

CCA enables an in-depth analysis of several million companies within Market Intelligence's datasets and includes a library of pre-defined (e.g., Network for Greening the Financial System (NGFS)^[3]) or user-defined scenarios. Projected financial statements are run via Market Intelligence’s statistical credit risk models to assess the impact on a current credit risk score (i.e., upgrade, downgrade or no change).

Figure 1 shows the credit risk implications of an orderly (O) and disorderly (D) energy-transition by 2050 for two NGFS scenarios (i.e., Net Zero 2050 and Divergent Net Zero), calculated via CCA for companies operating in five major carbon-intensive sectors. As can be expected, a disorderly transition will have more severe financial implications and, thus, credit risk implications than an orderly transition, particularly for the oil and gas sector. However, the orderly transition will also pose significant challenges that need to be taken into account and carefully managed to avoid increased credit risk crystallizing into actual default events. On a positive note, an orderly transition will also offer great opportunities for companies to improve their financial performance and credit risk profile, as can be inferred by the larger number of upgraded credit scores for this scenario shown in Figure 1.

Figure 1: Credit Risk Implications of the Net Zero 2050(O) and Divergent Net Zero(D) NGFS Transition Scenarios, by 2050.

CCA includes powerful tools to translate complex climate scenarios into drivers of financial performance and carry out counterparty and portfolio-level analysis for thousands of companies across many sectors. Users can project the full financial statement of individual companies over multiple scenarios, as well as identify the individual drivers of credit risk deterioration or improvement, all the way to 2050.

To learn more about CCA, please visit https://www.spglobal.com/marketintelligence/en/solutions/climate-credit-analytics.

Background Reference

[1] Climate Change: What are the Risks to Financial Stability?, Bank of England (2019) (available here).

[2] Paris Agreement, United Nations Treaty Collection (8 July 2016).