FITCH RATINGS: Climate Change’s Credit Implications For Structured Finance Visible In 10 years

Climate change’s credit implications for structured finance (SF) could be visible in transactions issued within the next 10 years, according to Fitch Ratings.

Existing Structural Finance notes benefit from mitigants that should insulate their ratings from climate-related risks could increase arrears and defaults and reduce some asset values.

Structured finance is a highly involved financial instrument provided to major financial institutions or companies with complex funding needs that are unmet with traditional financial items. Fitch divided climate change risks into policy risks from action (and inaction) by policymakers affecting economic growth and employment, asset price differentiation and borrower costs; physical risks, which may cause asset destruction or impairment and increase ancillary costs such as insurance; and transitional risks from economic and social responses, including technological adaptation that results in stranded assets.

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“We expect policy risk to be the first to become relevant for SF, followed by transitional and physical risks. Diversification, assets’ short average residual life and/or credit enhancement build-up should help shield many existing rated notes.

“We believe our rating assumptions are broadly consistent with potential ramifications of climate change risks for borrower performance and asset values, based on current expectations, knowledge, and data.

We apply specific additional stresses or sensitivities where implications are already more visible,” the report read in part.

More frequent and intense physical events and adaptation and policy response roll-outs, it says will make climate change more relevant for new SF transactions over the next 10 years. Of six key rating drivers in Fitch’s Global Structured Finance Criteria, it expects it to primarily affect asset quality.

According to the agency, Climate change’s effects will largely depend on localised impacts and individual portfolio characteristics, so underlying stresses will be uneven across regions and sectors.

It further noted that predicting their severity is difficult, but it initially expects assets with a longer residual life – chiefly residential and some commercial real estate – to be more vulnerable, making adaptation policies key.

At the United Nations (UN) Climate Change Conference recently, world leaders met and agreed on how to tackle the urgent threat of global climate change. Africa is already bearing the brunt of climate impacts as a consequence of dangerous climate change.

The need to scale up adaptation finance to protect the people and economies from the impact of climate change is clear. Some participants agreed that working with key partners such as the African Development Bank and others, this new suite of programmes will support African countries, including Nigeria, to adapt to the effects of climate change.