Fitch Ratings' proposed methodology to implement a screening tool to identify climate-focused risk in public finance this week earned a cautious thumbs-up from Municipal Market Analytics, which said it increases transparency around borrower climate risk but "could be better with enhanced disclosure."
According to
The total climate.VS is the result of combining an analysis of an issuer's physical risks and climate transition risks.
Flooding, wildfires and extreme wind are the primary physical risks that factor into the dynamic weighted average. Also taken into consideration are water stress, extreme precipitation, hail, heat and cold.
Transition risks entail the assessment of low-carbon economy-related dynamics as they apply to the sector.
Issuers would be rated on a scale from 0 to 100, with 100 being the higher end of risk. Issuers with a climate.VS of 50 or above by 2035 would undergo further evaluation to gauge whether the risks are properly reflected in their ratings.
"Our proposal was to publish only the scores that are 50 or above, because that is the threshold at which we're saying there could be potential credit implications in the future," said Arlene Bohner, head of U.S. public finance at Fitch.
"We are still taking the comments that we've received into account and going through those and thinking about them further," she said. "But we really want this to be grounded in the effect on credit."
Bohner stressed that the rating agency is open to feedback on its criteria at any time, even after the formal window for comment on this draft is closed.
This draft proposal is "unique, because it's not having a new participant come into the market to explain what the impact is going to be on municipal credit. It is well-known, well-respected municipal analysts conveying that risk," said Lisa Washburn, chief credit officer and managing director at MMA. "And that's an important development."
Washburn said there have been various modifiers or tags that have traveled with ratings over the years; for example, she said, when variable-rate debt was popular, there was a modifier that went along with that.
"This is really kind of taking that out and making it more transparent as to its impact," she said. "We lack good credit-related climate information. We can find out specific information from (the Federal Emergency Management Agency)'s website or one of the many vendors; but translating that into what it means for a particular credit, it's difficult."
Fitch coming in and providing that information on a credit-by-credit basis is "helpful," she said.
"It's a very constructive development for the market, if this moves forward," Washburn said.
"The framework that we are proposing is, in fact, just a screening mechanism," added Dennis Pidherny, managing director at Fitch. "It is not a direct correlation to upgrades, downgrades or affirmations."
Pidherny said the climate risk project stretches back several years, moving through the Fitch analytical teams, from corporates to infrastructure to, now, U.S. public finance.
"I think you can read from that that the concept has been well-received," he said. "We think it's a valuable service to investors, and… that's what we're here to do. We're here to serve the market."
Pidherny stressed that "the three perils that we are focused on at this point are wildfire risk, wind risk and flood risk." In revenue-supported sectors, they'll be looking at how those risks might affect issuers' ability to generate enough revenue through the provision of services.
For tax-supported debt, they'll examine how climate risks affect issuers' assets, operations and service area, and if they could reduce issuers' ability to generate enough revenue to meet their obligations, including whether natural disaster damage impacts the ability to levy and collect taxes in certain parts of cities.
They'll also be looking at the impact of the recovery from those risks on operations and costs.
Washburn said she'd like to see Fitch change its plan to publish scores only if they cross the threshold of 50, because it risks creating a binary in which investors take the "view that those issuers that have published scores are more risky than those that don't have published scores," when in fact two issuers with scores of 49 and 51 could be quite similar.
"This is relevant information for investors," she said. "Disclosing what makes up the score (in every case) would be helpful."
Bohner said Fitch expects to finalize these draft criteria at the end of the first quarter to the beginning of the second quarter.
