Moody's Investors Service will use national climate action commitments put forward as part of the Paris Climate Change Agreement in its analysis of the credit implications of carbon transition risk, the international credit ratings agency has said.

Under the Paris Agreement, governments have submitted national climate action plans (“Intended Nationally Determined Contributions” or “INDCs”) which will be ratcheted up over time so that governments can achieve their goal of keeping a global temperature rise this century well below 2 degrees Celsius and to drive efforts to limit the temperature increase even further to 1.5 degrees Celsius above pre-industrial levels.

"The near universal adoption of the Paris Agreement substantially increases the likelihood of coordinated and effective policies to materially reduce carbon and other greenhouse gas emissions over time, which has in turn the potential to become a significant ratings driver in a broad set of industries," said Brian Cahill, a Moody's Managing Director and Head of the Corporate Finance Group and Public, Project and Infrastructure Finance team in Asia Pacific.

"Our baseline scenario is a forecast of the global emissions pathway if all countries were to implement their national contributions put forward as part of the Paris Agreement," said Ilya Serov, a Moody's Senior Vice President.

"While not sufficient to meet a less-than-2°C warming objective, this baseline represents a plausible central scenario, given the current policy commitments of national governments and technology trends," added Serov.

Moody's has identified four primary categories of risk associated with carbon transition that it will use to assess the credit implications for corporate and infrastructure sectors. These categories are as follows:

1. Policy and regulatory uncertainty regarding the pace and detail of emissions policies;
2. Direct financial effects, such as declining profitability and cash flows, due to higher research and development costs, capital expenditure and operating costs;
3. Demand substitution and changes in consumer preferences; and
4. Technology developments and disruptions that cause a more rapid adoption of low-carbon technologies.

The Moody's report says that sectors and individual entities are likely to differ in terms of their ability to mitigate such risks based on their relative exposure and their financial, operational and technological flexibility.

Moody's has identified 13 industries in its corporate and infrastructure portfolio as most exposed to carbon transition risk. For three sectors — coal, coal infrastructure and unregulated power utilities — material credit impacts and rating adjustments are already being felt. For the others, Moody's expects that they will be affected over the next three to five years.

See the corresponding Moody’s press release