Sitting down with Myriam Durand from Moody’s to talk about ESG risk is an awakening experience. Ms. Durand, Managing Director of Corporate Finance for Europe, the Middle East and Africa, is sanguine about the still emerging place ESG occupies for how Moody’s looks at risk. And she cautions that we have come a long way in 15 years, and the pace of that journey is increasing for investors, corporates and sovereigns.
First, she points out that we “are witnessing the rise of the sustainable investor”. In a little over a decade, environmental, social and governance risk has moved from a footnote, to a headline in how investors are thinking about asset management. To demonstrate her point, she draws on an analysis, which illustrates the increasing use of carbon and tobacco filters, green inclusions and other ESG investing techniques applying to roughly $25 trillion in assets across all geographies. And the trend rose two-fold from 2012-2016:
I asked her what this really means, in light of the growing body of evidence that the world is actually facing worsening challenges on fronts like climate change. And her response is to concede that “yes, these numbers and the labels behind them do not necessarily connote investors driving impact on the ground, and there remain significant lapses in data transparency and comparability from companies. But, at least we are starting to use the right concepts for understanding emerging risk as the pressures on our planet continue to increase. Fifteen years ago, this kind of talk was non-existent.” And she leaves unanswered the question of what these numbers will mature into 15 years down the road.
But she does offer a clue by showing us first how risk will likely accumulate at a sector level due to ESG factors. She draws on an analysis of $68 trillion in rated debt across 86 sectors, considering both the materiality and timing of risk. And not surprisingly, the sectors most exposed are those that are the least resilient to a more carbon-regulated world:
And she adds that there are a couple of very interesting drivers of how this risk will continue to be priced. One, there is the “ongoing improvement in our ability to obtain material information on these sectors, some of which is not always apparent to the public. As our information continues to improve, so will the accuracy of this risk assessment.” And this is not just about risk but also opportunity, even in the most carbon intensive sectors.
When asked if it makes sense to avoid high risk sectors altogether from an investing perspective, she is careful to add some nuance. “Not all carbon intensive businesses are the same. Some are preparing their business models for transformation into a lower carbon world. And for these businesses, the decarbonisation of the planet is actually a significant emerging opportunity.”
And coming from one of the most important sources of financial risk analysis on the planet, this seems a profound statement. The implications are that in the next 15 to 20 years we will see enormous economic opportunity for those carbon intensive sectors which can transform themselves through innovation and business model adaptation. Even current players in carbon intensive sectors could be big winners as change accelerates in the physical world, and our ability to measure, manage and reward ESG performance improves commensurately.
And the rate of improvement in our ability to manage the problem is not random, which ties into the last big point Ms. Durand makes. Much of how this story plays out will depend on the regulatory approaches of nation states. And here the story grows perhaps a bit more ominous. This is how Moodys sees susceptibility to climate change at the sovereign level, combining both exposure (economic output at risk) and resilience (ability to withstand or mitigate the risk):
What is striking here is that the two countries with greatest anthropogenic output of GHG, China and the United States, appear to have the lowest levels of total risk exposure (green). Conversely, with India as a significant exception, those nations with relatively small contributions to the emissions pie are those with the most amount at risk. In other words, those with the most risk in general have the least direct leverage over policy which can help mitigate the problem. It’s a daunting situation, and the solution probably comes back to Ms. Durand’s earlier reflection on the opportunity side of climate change. That is, how do global businesses capture the climate change opportunity?
Ms. Durant offers some context for the path forward, “these themes are developing over ten, twenty, fifty years. It’s a big puzzle with a lot of moving parts. New technologies can bring immediate economic destruction and creation.” She adds, “think about what we have observed even over the last three years. Paris was a wakeup call. The financial community has woken up. The train has left the station, and it will not stop. The question is the pace of our train.” And what is clear is that Moodys’ continued analysis will provide transparency around the winners and losers on a journey we are all on, whether we choose to adapt or not.