Corporate and sovereign credit quality is likely to be impacted by heightened ESG risks in 2023, with contributing factors including greater scrutiny of climate-related plans and growing regulatory and political pressures exacerbated by the macroeconomic and geopolitical issues stemming from the Russia-Ukraine conflict and ongoing pandemic fallout, according to a new report by credit ratings, research, and risk analysis provider Moody’s Investors Service.

The report, 2023 ESG Outlook, identified four key ESG-related trends that Moody’s expects will impact credit this year, including growing scrutiny of corporate decarbonization plans, elevated social risks driven by high cost of living concerns, greater refinancing risk for lower-rated issuers with governance challenges, and an increasingly complex ESG regulatory and political landscape.

On the decarbonization front, Moody’s highlights the pressures likely to face sectors that are highly exposed to carbon transition risks that have yet to disclose detailed transition plans, such as oil and gas, mining and agriculture. Companies in these sectors may face increasing costs of capital as investors and financial institutions begin implementing their own net zero commitments, as well as demand pressures as companies begin scrutinizing their supply chains as efforts to address Scope 3 emissions ramp up. Overall, Moody’s estimates that 16 sectors with nearly $5 trillion of debt have high or very high inherent exposure to carbon transition risk.

Social risks impacting credit, according to the report, will stem from issues affecting access and affordability of basic services, such as high energy and food costs, exacerbated by the Russia-Ukraine conflict, putting pressure on policymakers still grappling with restoring pandemic-impacted fiscal positions to support vulnerable populations. According to Moody’s, these trends will have broad ranging implications for entities ranging from emerging market governments, energy and power sectors facing government windfall taxes, and consumer sectors facing reduced purchasing power and willingness to accept higher prices.

According to Moody’s, credit risk will rise the most for lower-rated entities which face higher liquidity and refinancing risks, given their tendency to exhibit more challenged governance attributes, with more leveraged capital structures and weak risk management policies, in an environment potentially more prone to external shocks. The report highlighted particular risk for speculative-grade non-financial companies in sectors including consumer products, restaurants and retail, as well as for lower-rated sovereigns with large 2023 maturities.

The report also highlighted the heightened regulatory and reputational risks impacting companies from an increasingly complex, and often conflicting policy and political landscape, such as companies that are facing growing pressure in many jurisdictions on their sustainability-related practices, while also dealing with pressure in some US states to minimize the integration of ESG considerations in their business and investment decisions. More broadly, growing requirements to provide ESG-related disclosure are expected to raise legal, regulatory and reputational risks for companies, both on their ESG positioning, as well as the potential for misrepresentation, particularly for financial institutions, as financial regulators turn their focus to addressing greenwashing concerns.

In addition to the forces impacting credit quality in 2023, the report also identifies a series of “ESG trends to watch” for their future credit implications, including enhanced understanding of the financial costs of physical climate risks and adaptation, the integration of Just Transition considerations in energy transition plans, growing regulatory attention on natural capital and biodiversity issues, and increasing pressure on companies to implement circular economy practices to reduce waste and re-use content.

Rebecca Karnovitz, Vice President – Senior Credit Officer at Moody’s Investors Service, said:

“Heightened macroeconomic, financial and geopolitical risks stemming from the fallout of the COVID-19 pandemic and the Russia-Ukraine conflict will likely continue to exacerbate ESG risks in 2023. Meanwhile, the rapid crystallization of climate change-related risks have highlighted the need for rapid decarbonization and scaling up of adaptation finance, bringing longer-term environmental risks into sharper relief.”

Click here to access Moody’s 2023 ESG Outlook.

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