Credit Rating Agencies Warn Climate Risk Could Trigger Mass Bond Downgrades

Fitch Ratings, S&P Global and Moody's Investors Service have each issued warnings that accumulating climate-related risks will likely result in significant credit rating volatility for carbon-intensive issuers within the next decade. IEEFA warns that the reactive nature of current rating methodologies is creating a financial time bomb for bond markets, particularly for investors in hydrocarbon-dependent issuers.

Fitch Ratings indicated in 2023 that approximately 20% of global corporates — primarily oil and gas producers and midstream energy companies — could face downgrades by 2035 due to climate vulnerability exposure. S&P Global Market Intelligence found in a scenario analysis of an orderly energy transition by 2050 that companies in five carbon-intensive sectors — airlines, automotive, metals and mining, oil and gas, and power generation — faced a 31% to 54% downgrade risk. A disorderly transition would raise the downgrade risk by a further 2% to 20%. Moody's separately reported in October 2022 that sectors with high inherent climate risk accounted for 10% of total rated debt outstanding.

The core problem, according to IEEFA, is that credit rating methodologies are structured to be reactive rather than proactive, relying on historical data and statistical evidence before adjusting ratings. Climate risks are growing but remain forward-looking and uncertain, meaning they are not yet triggering rating actions even as the underlying exposure accumulates. S&P acknowledged it had taken very few climate-related rating actions since early 2022, citing the gap between policy pledges and tangible regulatory effects. The result is that bond markets are operating with ratings that understate the true credit risk of carbon-intensive issuers.

IEEFA recommends that regulators require credit rating agencies to adopt forward-looking climate risk assessments, including standalone climate risk scores and double rating analyses that incorporate future cash flow impacts from climate scenarios. Rating committees should also include non-voting independent climate specialists. Regulators should additionally require agencies to disclose the magnitude of any methodology adjustments resulting from material climate risks, consistent with European Central Bank guidance. Without proactive reform, long-term investment-grade bonds held by hydrocarbon-dependent issuers face a high risk of multi-notch downgrades and sweeping sell-offs.

Key figure — 20% of global corporates — mainly oil and gas and midstream companies — face potential downgrades by 2035, per Fitch Ratings.