Commentary

Climate and Credit: Short-Term Headwinds, Long-Term Risks

ABCP, Auto, RMBS

Summary

In the first edition of the Climate Risk Navigator, Morningstar DBRS compares various energy transition scenarios and identifies the ones that best reflect our credit rating analysis. The energy transition is transformative, and we discuss the differentiation between the credit relevance or significance of climate considerations in our credit ratings, and scenario analysis or stress testing related to climate risk. We briefly discuss the climate change pathways that can result from different energy transition scenarios.

Key Highlights:
-- Our credit ratings consider implemented climate policies and regulations, whose effects tend to last over the typical credit rating horizon. Current climate policies are already transformative with credit relevance in some sectors and segments.
-- Based on current climate policies, the world is not on track to meet the Paris Agreement. This increases the potential costs and disruption that could be caused by a future abrupt transition. While this is a consideration, the likelihood of a substantially accelerated transition over the typical credit rating horizon is currently low. At present, our credit ratings do not incorporate the potential costs of a more abrupt transition.
-- Absent major technological breakthroughs when it comes to carbon capture, staying on the current path or slowing the transition will incur costs because of the increased physical climate risk in the long term, at the very least giving rise to substantial climate change adaption costs.

"We assess the materiality of the energy transition by considering the visible actions and trends. These are most closely reflected in scenarios that incorporate current climate policies", says Christian Aufsatz, Managing Director, European Structured Finance Ratings. "More transformative energy transition scenarios remain uncertain but can be valuable for investors as scenario analysis or stress testing that form part of climate risk management".

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