Do credit rating agencies capture climate risk?

Floods destroy factories. Wildfires shut down supply chains. Carbon taxes eat into margins. Climate change is no longer a distant concern for firms. It is a source of real measurable financial risk. Credit rating agencies should in theory be capturing this. The question is whether they do.

S&P, Moody’s and Fitch have each incorporated environmental, social and governance (ESG) factors in their credit frameworks, although differently. Fitch publishes ESG relevance scores alongside its ratings and recently updated its general ESG approach [1]. Moody’s built ESG issuer profile and credit impact scores but wound down its standalone ESG solutions business in 2024 and handed data to MSCI [2]. S&P dropped its numerical ESG credit indicators in 2023 and discussed environmental factors in prose instead [3]. All three signed the UN PRI commitment to factor ESG in credit opinions. Yet the effect on actual ratings remains limited: climate considerations still account for a small fraction of rating changes [4].

After the 2024 US election, the political ground shifted. The SEC pulled back from climate disclosure rules and anti-ESG legislation swept through state legislatures [5]. Agencies operating across jurisdictions face contradictory pressures: European regulators and investors expect climate risk in credit analysis, while Washington runs the other way.

The EU’s ESG Ratings Regulation, which is effective from July 2026, sets transparency and governance rules for standalone ESG rating providers [6]. But it does not apply to credit ratings issued under the existing CRA Regulation. How agencies handle climate risk in their core credit product remains up to them. The ECB has flagged this gap and is pushing for better integration through its collateral framework and supervisory engagement [7].

How well do credit ratings actually reflect climate risk? In a recent study in the Journal of Corporate Finance, we examined this using S&P long-term issuer ratings for over 2,200 non-financial firms in 67 countries between 2005 and 2022 [8].

We find that higher carbon emissions are associated with lower ratings. Agencies do penalise transition risk. Moving from a low- to high-emission profile is associated with roughly a quarter-notch rating drop. What stands out is that the effect gets worse when a firm is also exposed to physical climate hazards. We call this the ‘twin threat’: transition and physical risks reinforce each other, producing a larger rating impact than either alone.

Not all firms are equally affected. Solid balance sheets, active environmental management and credible net-zero commitments appear to attenuate the negative association between transition exposure and ratings, which reassures agencies that regulatory and reputational risks are managed. But they do not help with physical climate risk. A firm can cut emissions and align with Paris targets, yet this does not change how agencies assess its exposure to floods, wildfires or rising seas. Physical risk is global, driven by warming, and firm-level mitigation does not carry over; addressing it requires coordinated global action. Still, firms are not powerless. Those investing in adaptation by hardening infrastructure and building resilience appear to face a less severe rating impact from physical exposure. Agencies seem to distinguish between preventing climate change and preparing for its consequences. This distinction matters for investors, who use ratings as an investment compass, particularly those treating climate risk as material. Now the regulatory question is whether agencies should be required to disclose how they factor in climate risk or left to treat it as any other risk.

References

[1]      Fitch Ratings (2026). “Fitch Ratings Publishes General ESG Approach.” 29 January 2026. https://www.fitchratings.com/research/corporate-finance/fitch-ratings-publishes-general-esg-approach-29-01-2026

[2]      Responsible Investor (2024). “Moody’s Closes ESG Ratings Business.” https://www.responsible-investor.com/stakeholders-wary-of-market-consolidation-as-moodys-closes-esg-ratings-business/

[3]      Environmental Finance (2023). “Surprise as S&P Drop ESG Scores from Credit Ratings.” https://www.environmental-finance.com/content/analysis/surprise-as-s-and-p-drop-esg-scores-from-credit-ratings.html

[4]     Piloiu, A., Reichmann, O. and Resch, F. (2025). “Credit Ratings: How the ECB Strives to Properly Account for Climate Risks.” The ECB Blog, 7 November 2025. https://www.ecb.europa.eu/press/blog/date/2025/html/ecb.blog20251107~54c4d00c0a.en.html

[5]      SLR Consulting (2025). “What the ESG Backlash Means for America.” https://www.slrconsulting.com/us/insights/what-ESG-backlash-means-for-America/

[6]      European Commission (2024). Regulation (EU) 2024/3005 on the Transparency and Integrity of ESG Rating Activities. Official Journal of the European Union. https://eur-lex.europa.eu/eli/reg/2024/3005/oj

[7]      ECB (2022). “ECB Takes Further Steps to Incorporate Climate Change into Its Monetary Policy Operations.” Press Release, 4 July 2022. https://www.ecb.europa.eu/press/pr/date/2022/html/ecb.pr220704~4f48a72462.en.html

[8]      Borsuk, M., Du, Z., Duan, T., Kowalewski, O., Qi, J. and Shrimali, G. (2025). “Twin Threats: The Compound Effect of Transition and Physical Climate Risks on Firms’ Credit Ratings.” Journal of Corporate Finance, 98, 102710. https://doi.org/10.1016/j.jcorpfin.2025.102710