ECB focuses on climate risk in credit assessments

The ECB has identified gaps in climate-related information provided by credit ratings agencies, and outlined its own common minimum standards for incorporating climate risks into in-house credit assessment systems used by Eurosystem central banks.

An analysis published in the ECB’s latest economic bulletin finds that information provided by 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”.

Using an analytical framework based on 11 discrete criteria, the paper compares the climate-related definitions, methodologies, assessment models, data usage and disclosure practices of four credit rating agencies accepted by the Eurosystem as part of its Eurosystem Credit Assessment Framework. It reveals large differences in methodologies and disclosure practices rating agencies and asset classes.

Issues identified include a lack of granularity in agency disclosures, with conflation of physical climate risks with transitional risks such as carbon pricing, regulation and reputation. The magnitude of the potential impact of climate risks is also “rarely disclosed”, while potential spill-overs to society and governance are largely ignored.

The paper offers recommendations to improve the granularity of material climate risks in disclosures, along with their aggregate magnitude. In addition, it calls for greater transparency around the models and methodology used by agencies to estimate climate-related exposure.

Also published in the bulletin is a summary of common minimum standards for incorporating climate change risks into ratings for in-house credit assessment systems of Eurosystem central banks. Among the core principles outlined is a requirement that “the analysis of climate change risks must meet the same high standards for quality and reliability as the assessment of any other risk factor and must be integrated into the regular rating process”.

The standards also specify requirements concerning data sources, methodology and processes to be used. They also encourage assessment of climate risks at firm level and use of “state-of-the-art techniques”, such as forward-looking approaches using scenarios developed by the Network for Greening the Financial System.

Eurosystem central banks assessing climate risk are also asked to “document their data sources and usage, and the methods and processes used to assess climate change risks” in order to increase the transparency and objectivity of analysis.

Announced last July, the standards have been agreed by the ECB and will come into force by the end of 2024.