ESG Portfolio Services: Moody’s – Central Bank
Over the past several years, Moody’s has combined its credit risk expertise with new analytical capabilities to measure environmental, social and governance risks (ESG) The factors. These new tools enable central banks – and other investors – to identify, analyze and measure portfolio exposures to physical and transition risks. ESG risks.
For example, the company has been working with the Banque de France for four years, supporting it in monitoring ESG exposures of its reserve assets. The work revolves around two portfolios that include investments in sovereign bonds, corporate bonds and equities. Moody’s provides annual updates regarding exposure to physical climate risks as well as assessments on factors such as the biodiversity footprint or human rights record of corporate bond issuers linked to investments .
The company has developed data-driven services related to the measurement of physical and transition risks, among others. “By building larger ESG capabilities across its businesses, Moody’s has developed a cohesive, customer-centric offering with clear use cases for its diverse customer base,” said Keeran Gwilliam-Beeharee, executive at Moody’s. ESG The Solutions Marketing and Engagement Team.
“The company completed the acquisition of two companies specializing in ESG and climate data in 2019. And it’s been over 2020 and 2021 since Moody’s brought these new ESG market solutions.
One of the services deals with physical climate risk. This service studies the exposures of thousands of businesses to floods, heat stress, hurricanes and typhoons, sea level rise, water scarcity and wildfires, and offers an assessment demand risks for real assets, corporates, sovereigns and sub-sovereigns.
“We have a database that tells us where the facilities – including offices, manufacturing sites and major shopping centers – of the world’s largest companies are located. We mapped this to climate and environmental data to identify the percentage of facilities operating in areas exposed to physical hazards,” says Léonie Chatain, Climate Products Specialist at Moody’s.
It is an online tool for real assets that allows clients to access physical risk scores at a granular level for any location in the world. When entering an address, the platform provides a report on that location’s exposure to physical risks, i.e. the potential physical impact of climate change at that location.
Multiple data sources
Moody’s assesses physical risk through a wide range of data sources. A point of reference is the Intergovernmental Panel on Climate Change (IPCC), and the models it offers. “These are the main references for understanding how the concentration of greenhouse gases [GHG] is likely to have an impact on temperatures and precipitation,” says Chatain. “We also have large environmental datasets on flood risk, topography, hydrology, etc.”
For climate and governance-related transition risks, the datasets measure a portfolio’s alignment with the European Union taxonomy or the Task Force on Climate-Related Financial Disclosures (TCFD) framework. These include carbon footprint, brown/green assessment, temperature alignment, energy transition and TCFD reporting data from 5,000 companies, with rapidly expanding coverage.
Moody’s also uses data from organizations such as the International Energy Agency (OUCH) to better understand the real impact that the company’s objectives will have on the reduction CO2 emissions. It also determines whether their plans belong to keeping a global temperature increase limited to 2°C or, on the contrary, to a trajectory of 4°C.
For its transition risk assessment, Moody’s augments the underlying data from its ratings and data platforms with public information taken directly from corporate reports. “For example, when we talk about carbon footprint, we look at the company’s disclosure and collect that information,” Chatain explains. “Then this is extracted by our team and analyzed in a way that makes sense to market participants, to then extract important insights for central banks and other types of financial institutions.”
In addition, Moody’s offers climate-adjusted macroeconomic forecasts with an 80-year horizon, as well as a climate-adjusted probability of default for listed and unlisted companies. This service is powered by the expected default frequency pattern.
Beyond portfolio management
These services have also supported central banks in their role as banking supervisors. For example, in preparing for its first climate change stress tests, which take place in the first half of 2022, the European Central Bank sought to understand the physical risk exposures of its supervised entities.
Moody’s has worked with Four Twenty Seven’s physical risk tracking software to locate millions of small and medium-sized business facilities around the world and rated them according to the level of physical climate risk to which they are exposed. The company also offered country-level macroeconomic scenarios and a breakdown of risk exposure across sectors and geographies.
In addition, the supervisory division of the Dutch bank called on the services of Moody’s to carry out a study on the exposure to biodiversity risk on the balance sheets of its supervised entities. This study was published in June 2020 and is titled indebted to nature.
Similarly, the Bank of England has taken advantage of the software, using data on the physical risk profile of sovereigns as well as large corporations, to improve its risk management practices and climate-related financial information. Moody’s analyzed each facility individually to arrive at an enterprise-level score. Additionally, the central bank uses these scores for quantification measures through the climate-adjusted probability of default.
Overall, Moody’s ESG The solutions’ new datasets and software capabilities for identifying and measuring physical transition risks are important new tools for central banks as they seek a clearer ESG position for the management of their reserves or to deal with potential stability risks related to the risk exposure of the financial institutions they supervise.
The Central Banking Awards were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Victor Mendez-Barreira, Ben Margulies and Riley Steward