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Climate change and the financial sector - New trends in the financial sector

COP 21: Clear policy agenda and better disclosure needed to channel private investment

By Madelain Michel - President and Chief Operating Officer, Moody's Investors Service

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The Paris COP 21 agreement sent a strong signal about policymakers’ determination to counter climate change and build a greener economy. The ultimate success of this agenda now depends on how different parties’ commitments will be translated into specific actions.

This is a tall order, as it is likely to require a partial rethink of the economic and business models for important parts of our economies, at a time of elevated concerns and focus on economic growth and financial stability.

Moody’s is analysing and mapping the effects of environmental risks and their impact on creditworthiness, assessing their materiality and time horizon. We broadly define environmental risks as the adverse effects of direct environmental hazards and regulatory and policy initiatives.

We found that in the shorter-to-intermediate term, climate-change related regulations and policies are already material credit drivers or could be in three-to-five years, especially in some industries such as coal as well as unregulated utilities and power generation companies.

We identified 11 sectors, accounting for approximately $2 trillion of rated debt, where the credit implications of carbon regulations are material or could become so. For other potentially impacted sectors, the long projected time frames of the economic and business risks of climate change, and the longer runway available to respond, make this assessment more challenging. However, the long time span is also likely to mitigate the impact of risks to creditworthiness.

Improved disclosure by market participants is needed to enhance the assessment of the financial implications for investors.

Clarity and consistency of the policy agenda post-COP 21 is critical to provide the private sector with a credible and clear operating framework to assess risks and channel investment. Uncertain or shifting political priorities are key criteria that investors will consider in their capital allocation decisions.

Similarly, improved disclosure by market participants is needed to enhance the assessment of the financial implications for investors – a task the Financial Stability Board has most recently taken on board. If these conditions are met, there is no reason to believe that the financial system cannot support the transition to a greener economy.