ESG portfolio services: Moody’s

Over the last few years, Moody’s has combined its expertise in credit risk with new analytical capabilities to measure environmental, social and governance (ESG) factors. These new tools enable central banks – and other investors – to identify, analyse and measure portfolio exposures to physical and transition ESG risks.

For instance, the company has worked over the past four years with Banque de France, 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 the exposure to physical climate risks as well as assessments on factors such as the biodiversity footprint or the human rights record of corporate bond issuers related to the investments.

The company has developed data-driven services related to measuring physical and transition risks, among others. “In building out broader ESG capabilities across its business, Moody’s has developed a coherent, customer-centric offering with clear use cases for its diverse customer base,” says Keeran Gwilliam-Beeharee, an executive in Moody’s ESG Solutions’ marketing and engagement team.

“The company completed acquisitions of two companies specialised in ESG and climate data back in 2019. And it’s been over 2020 and 2021 that Moody’s has been bringing these new ESG solutions to the market.”

One of the services focuses on physical climate risk. This service studies exposures of thousands of companies to floods, heat stress, hurricanes and typhoons, sea level increases, water scarcity and wildfires, and it offers on-demand risk-scoring for real assets, corporates, sovereigns and sub-sovereigns.

“We have a database that tells us where the facilities – including offices, manufacturing sites and main retail centres – of the world’s largest corporations are located. We’ve mapped that to climate and environmental data to identify the percentage of facilities operating in areas exposed to physical risk,” says Léonie Chatain, climate product specialist at Moody’s.

This is an online tool for real assets that enables customers to access physical risk scores at a granular level for any location in the world. Upon introducing an address, the platform provides a report on that location’s exposure to physical risks, meaning the potential physical impact of climate change there.

Multiple data sources

Moody’s assesses physical risk through a wide set of data sources. One reference point is the Intergovernmental Panel on Climate Change (IPCC), and the models it provides. “These are the main references to understand how the concentration of greenhouse gases [GHG] is likely to impact temperatures and precipitation,” says Chatain. “We also have extensive environmental datasets on flood risk, topography, hydrology, etc.”

In relation to transition risks related to climate and governance, the datasets measure a portfolio’s alignment to the European Union taxonomy or the Task Force on Climate-Related Financial Disclosures (TCFD) framework. These include the carbon footprint, brown/green assessment, temperature alignment, energy transition and TCFD reporting data for 5,000 companies, with coverage rapidly expanding.

Moody’s also uses data from bodies such as the International Energy Agency (IEA) to better understand the actual impact that company targets will have on reducing CO2 emissions. It also determines whether their plans belong to keeping an increase of global temperatures limited to 2°C or, in contrast, a 4°C pathway.

For its transition risk assessment, Moody’s bolsters the underlying data of its scoring and data platforms with public information derived directly from corporate reports. “For example, when we talk about carbon footprint, we’ll be looking into the company disclosure and collecting that information,” says Chatain. “Then this is extracted by our team and analysed in a way that makes sense for market participants, to then extract important information for central banks and other types of financial institutions.”

Additionally, Moody’s offers climate-adjusted macroeconomic forecasts with an 80-year horizon, as well as climate-adjusted probability of default for listed and unlisted companies. This service is powered by the expected default frequency model.

Beyond portfolio management

These services have also supported central banks in their roles as bank supervisors. For instance, in preparing its first climate change stress tests, which are taking place in the first half of 2022, the European Central Bank sought to understand the physical risk exposures of its supervised entities.

Moody’s worked with Four Twenty Seven’s physical risk software tracker to locate millions of facilities of small and medium-sized enterprises worldwide, and scored them according to the level of climate physical risk to which they are exposed. The company also offered macroeconomic scenarios at the country level, and distribution of risk exposure across sectors and geographies.

Additionally, the supervisory division of the Netherlands Bank has used Moody’s services to perform a study into the biodiversity risk exposure on its supervised entities’ balance sheets. This study was published in June 2020, and is titled Indebted to nature.

Similarly, the Bank of England has benefited from the software, using data on the physical risk profile of sovereigns as well as large corporations, to enhance its risk management practices and climate-related financial disclosures. Moody’s analysed each facility individually to arrive at a corporate-level score. Additionally, the central bank is using these scores for quantification metrics through climate-adjusted probability of defaults.

Overall, Moody’s ESG Solutions’ new datasets, and software capabilities to identify and measure physical transition risks, are important new tools for central banks – whether they are seeking a clearer ESG position for their reserves management or addressing potential stability risks related to risk exposures 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