Climate & businessClimate change will worsen natural catastrophes’ impact on corporate creditworthiness: S&P
Generally, companies have so far managed to mitigate the effects of natural catastrophes through liquidity management, insurance protection, natural disaster risk management, and post-event recovery measures. The more frequent and extreme climatic events many scientists predict, however, could adversely affect companies’ credit profiles in the future. Standard & Poor’s says that greater disclosure of firms’ exposure to extreme natural catastrophes should encourage them to bolster their resilience to these events and thereby aid transparency.
While recent history shows that natural catastrophes may have not been a major rating factor on corporate credit quality in the past, their effect in the future may increase considerably as we experience more frequent and extreme climatic events, says a report published last week by Standard & Poor’s Ratings Services. Moreover, globalization will exacerbate the effects of such catastrophes.
Titled Change Will Likely Test the Resilience of Corporates’ Creditworthiness to Natural Catastrophes, the report points out that so far, rated companies have been able to mitigate any negative impact through a combination of liquidity management, insurance protection, disaster risk management, and post-event recovery measures. The report’s authors say, however, that they believe these measures could become considerably less effective in future.
Standard & Poor’s says that although natural catastrophes can result in companies experiencing property losses and production and market disruptions, such events are not frequently a factor behind S&P negative rating actions. Since 2005, S&P has identified natural catastrophes (tropical storms, floods, droughts, and earthquakes) as the main or material contributing factor for at least sixty negative rating actions (comprising downgrades and outlook revisions). This compares with about 6,300 corporate credit downgrades on companies in total over that period.
In around 70 percent of cases, natural catastrophes led to a one-notch downgrade or a negative outlook that S&P subsequently resolved by affirming the rating. Across the rest of the sample, natural catastrophes contributed to multi-notch downgrades, and in about 10 percent of cases to default. Overall, this affected nearly twice as many speculative-grade than investment-grade companies because the former are more vulnerable to a downgrade, as S&P default statistics illustrate.
Looking ahead, the effects of climate change may increase the severity and frequencies of natural catastrophes. At the same time, growth in exposure in areas with high risk to extreme events, coupled with increased integration of the world economy through complex global supply chains, may exacerbate the effects of such catastrophes. This is because in an increasingly interconnected world, a major local natural catastrophe affecting an important link in the global economy is likely to have a worldwide and long-lasting impact.
Because S&P expects the frequency of natural catastrophes, along with their economic effects, to increase in the future, companies will, in S&P view, need to improve their level of disclosure about their exposure to such events. In that regard S&P considers that the insurance industry’s 1-in-100 Initiative should provide more insight into the resilience of companies to such events.
— Read more in Miroslav Petkov and Michael Wilkins, Change Will Likely Test the Resilience of Corporates’ Creditworthiness to Natural Catastrophes, RatingsDirect, Standard & Poor’s Ratings Services (McGraw Hill Financial, 20 April 2015); and Resilience: Integrating Risks into the Financial System: The 1-in-100 Initiative Action Statement, Climate Summit 2014 (UN Headquarters, New York, 23 September 2014)
