A new report has demonstrated that by not adequately accounting for climate risks, rating agencies could be repeating the mistakes of the credit crisis where risk was underestimated to the detriment of the global financial system.
The report, (Mis)Calculated Risk and Climate Change – Are Rating Agencies Repeating Credit Crisis Mistakes, was launched on Wednesday.
By not factoring in climate risk, credit rating agencies are assuming a business as usual approach to fossil fuel investment, which would result in 4 degrees Celsius or greater warming of the planet, according to the report.
However, nearly 200 nations have agreed to limit global warming below 2 degrees Ceilsius, with a number of nations calling for below 1.5 degrees Celsius. Even as governments work together to achieve that goal, there is a growing trend in international, national, business, consumer, legal, regulatory, and social efforts to mitigate climate change and avoid the current trajectory, the report said.
In assuming a business as usual scenario, rating agencies may be artificially inflating the credit ratings and financial value of companies that contribute to global warming. This poses significant risks for investors, and the climate, and could expose rating agencies themselves to legal liability.
"Fossil fuels are on the way out," said Niranjali Amerasinghe, Director of the Climate & Energy Program at CIEL. "Overstated credit ratings threaten not only investors and markets, but ultimately the global economy. They also contribute to overinvestment in activities that cause climate change, threatening our ecosystems and the people who depend on them," she said.
The report highlights the case of the Abbot Point coal terminal in Australia and demonstrates how Moody’s Rating Agency failed to seriously consider how a dynamic climate trajectory could negatively affect the investment, resulting in a potentially inflated credit rating.
If rating agencies fail investors, individuals, and financial regulators again, credit rating agencies could face potentially significant legal risk, said the report.