ECB finds gaps in credit rating agencies’ disclosure of climate change risk

Insufficient disclosures by Morningstar, Fitch, Moody’s and S&P make it hard to disentangle the impact of climate change on credit ratings, according to a review by the European Central Bank.

ECB researchers found that information provided by credit ratings agencies does not allow users “to draw a definite conclusion on what would have been the credit rating in absence of climate change risk”.

The lack of granularity in disclosures means that transition and physical risks – and their sub-categories such as regulation, carbon pricing, reputation and others – are often lumped together, while the magnitude of their impacts are “rarely disclosed”.

In addition, CRAs mainly assess climate change risks within the environmental pillar “although it is understood” that there could be potential spill-over to social and governance dimensions, which could in turn impact credit ratings.

It is also difficult to ascertain whether climate change factors that feed into credit ratings are informed by broader industry-wide assessments or entity-specific considerations, said the supervisor.

The ECB has developed and published a framework alongside the review to aid users to perform a “systematic and consistent assessment” of CRA methodologies on climate risk. Applying the framework to status quo CRA disclosures suggests that more granular disclosure requirements could be introduced by regulators, it concluded.

The paper, published this week, forms part of the ECB’s action plan as it deliberates on how to include climate change considerations in its monetary policy strategy. The central bank relies on credit assessments when accepting collateral from financial institutions and making outright asset purchases under quantitative easing.

In July, the ECB announced stricter environmental restrictions on eligible collateral and investment portfolios in an effort to reduce its exposure to climate-related risks and support the green transition.

The four CRAs are the only providers of credit assessments which are currently accepted by EU central banks and the review “does not allow conclusions to be drawn on other rating agencies”.

It follows a separate consultation by the European Commission on whether CRA disclosures were sufficient to enable market understanding on how ESG factors influence ratings. More than half of respondents supported non-legislative initiatives, such as issuing additional guidelines and supervisory actions through securities regulator ESMA, to enhance disclosures.