Climate-related financial risk needs to go mainstream

In July, Moody’s announced the acquisition of a controlling stake in climate risk assessment firm Four Twenty Seven. As discussed here previously, Four Twenty Seven has detailed analysis on the climate risk exposure of US cities and counties that helps factor climate change into assessing munibond risk. 

This is crucial information for companies and communities, as well as the financial institutions that lend to them. Clearly Moody’s has realized the risks associated with climate change and more broadly with environmental, social and governance issues – in April the ratings agency bought a majority stake in ESG risk analysis firm Vigeo Eris. 

The impact of climate change-related events on muni risk is no joke – particularly for US cities. Some 63 of America’s most populous 75 cities do not have enough money to pay all of their bills, according to research earlier this year from muni finance watchdog, Truth in Accounting. In the bottom 15 of that list you’ll find coastal cities such as Miami, New Orleans, San Francisco, Honolulu and New York. 

Brutal downgrades

For those cities that have not adopted climate mitigation strategies, a credit downgrade due to increased risk is going to be brutal. According to Risk & Insurance: “A city of 100,000 with $900 million dollars of debt that experienced a one-step downgrade in credit rating would, as those bonds get issued, experience an increased borrowing cost of $2 million per year or $40 million over the life of a 20-year bond.” 

That’s just a one notch downgrade for a small city. Miami, for example, has a $2.1 billion shortfall; New York’s is $185.5 billion, according to Truth in Accounting. 

There is so much risk embedded in every market as a direct or indirect result of climate change – as well as the current demand for not just a cleaner but a fairer society – that it can seem impossible to fully grasp the implications. 

In July, for example, India’s finance minister Nirmala Sitharaman talked of the value of zero budget farming – where no chemical fertilizers are used – not only to improve crop yields but also livelihoods, water quality and land resiliency to drought or flood. Immediately after her statement, the share price of India’s largest fertilizer and agrochemical companies tanked – by as much as 12% in the case of Madras Fertilizers. 

As frustrating as it is that the ratings agencies have only recently taken this seriously, at least they are finally doing so now 

It is not a stretch to see other countries following India’s lead on chemical-free farming – there’s already a global regenerative agriculture movement – and that spells stress for the banks that lend to agrochemical industries, as well as for investors in these firms. 

Is such risk being factored into credit worthiness? Policy changes will come thick and fast over the next decade, and many of the impacts are unpredictable. Will there be policy shifts around forestry that impact the timber, pulp and paper industries? What about the fishing and shipping industries? Will there be tax increases on real estate development, or tougher requirements for environmental protection on infrastructure projects? 

And beyond policy changes, what about consumer pressure or litigation risk, as shown by Bayer’s 30% share price decline this year after its purchase of agrochemical company Monsanto? 

Risk assessment

Indeed, any industry that relies on natural capital and ecosystem services or that has an impact on the natural environment is at great risk of change in the coming years – and that makes financial risk assessment both crucial and challenging in a way that is new. Even ecologists, conservationists and climate scientists do not fully understand what we are facing. 

Some bankers have pointed out to me that Moody’s acquisition only proves that there is so much risk in the system that has not been accounted for. How much 10- to 30-year debt has been issued that has not taken these new risks into account, for example? 

As frustrating as it is that the ratings agencies have only recently taken this seriously, at least they are finally doing so now. And the notion of climate-related financial risk needs to start trickling down into mainstream consciousness.

I recently visited a town on the US Gulf Coast where people are struggling to get by. Some rely on the abundant source of shrimp and fish, while others have been able to make a success of offering ancillary services to the oil and gas companies and their employees on offshore rigs. 

That town is on a spit of land in the middle of subsiding wetlands; if the oil and gas industry there can no longer be serviced from its port due to coastal erosion, then several thousand local jobs are at risk. 

There are, therefore, local efforts to bring investment to infrastructure and coastal restoration. But even if such efforts are successful, what will happen to this community in 15 to 30 years when the oil and gas industry is replaced by clean energy? I couldn’t find anyone who had thought that far ahead – despite the fact that many were owners of 15- to 30-year mortgages. 

I have no doubt this resilient community will come up with ideas to transition its economy, but many of them simply weren’t aware of what was coming. The sooner we embed climate risk into all financial decisions, the better for everyone. 

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