Finance and insurance company Fitch Ratings has released a discussion paper outlining its plans to use its Climate Vulnerability Scores (Climate.VS) to enhance its process for identifying potentially credit-relevant climate-related risks for credit ratings for nonfinancial corporates.
So far, material impacts of climate-related risks on credit ratings have been limited to certain sectors, principally utilities, but Fitch Ratings says it believes the pace and breadth of climate change policies will accelerate over the coming years.
“This proposal will put Fitch Ratings, and our users, in a stronger position to identify and react to these changes,” it posits.
Fitch Ratings plans to use its existing sector-level Climate.VS as a screening tool to identify entities that are potentially more vulnerable to climate-related risks, based on a specific entity-level Climate.VS threshold and time horizon.
It will then subject these entities to additional analysis and consideration in its credit rating committees. Scores assigned to entities, and the results of this additional analysis where performed, will be disclosed in the company’s entity-specific rating reports.
Where climate risks are key rating drivers, these drivers will continue to be disclosed in the applicable rating action commentaries.
The scores are focused on transition rather than physical risks, as Fitch Ratings believes climate-related policy, market and regulatory risks are likely to have a more severe credit impact on corporates as a whole in the first half of this century than the physical risks from climate change itself.
In 2022, the company released 13 sector-level Climate.VS reports covering all the major nonfinancial corporate sectors, and these have been re-released, with minor updates, as part of this exercise.
The sector-level Climate.VS shown in these reports, covering over 120 subsectors, set out Fitch Ratings’ views of the relative risk of these subsectors under the UN Principles for Responsible Investing’s Inevitable Policy Response Forecast Policy Scenario, where global warming is limited to below 2 °C above preindustrial levels.
The reports set out how these risks, and relative vulnerabilities, will evolve between 2025 and 2050.
Fitch Ratings plans to produce scores at an entity level based on the split of a company’s operations, as it believes sector risk is the most relevant determinant of risks to corporates today.
To fully explore the implications of this enhancement and gather evidence to assist in its analysis of whether to go forward with this proposal, the company plans to implement, on a trial basis, the entity-level Climate.VS screener in its credit ratings, and the proposed disclosures in its rating reports, along with a request for feedback.