Climate Change-Related Legal And

Regulatory Threats Should Spur

Financial Service Providers To Action
Primary Credit Analyst:
Miroslav Petkov, London (44) 20-7176-7043; miroslav.petkov@spglobal.com
Secondary Contacts:
Alexandre Birry, London (44) 20-7176-7108; alexandre.birry@spglobal.com
Stuart Plesser, New York (1) 212-438-6870; stuart.plesser@spglobal.com
Michael Wilkins, London (44) 20-7176-3528; mike.wilkins@spglobal.com

Table Of Contents
Quantifying The Effect Of Climate Change Starts With Good-Quality Data
Changing Attitudes Could Bring New Responsibilities
The Tangible Financial Impact May Initially Be Low, But Will Grow
Macroeconomic Changes May Hurt The Most
Despite Everything, Climate Change Also Offers Opportunities
Indicators For Measuring Exposure To Climate Change
This Emerging Risk Has Long-Term Implications
Appendix: How We Capture Climate Change Exposures In Our Rating
Analysis
Related Criteria And Research

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Climate Change-Related Legal And Regulatory

Threats Should Spur Financial Service Providers
To Action
The impact of climate change on banks, insurers, and asset managers (financial services companies) is likely to be
multilayered and significant over the long term. Climate change could have broad-based consequences for companies'
investments and loan portfolios; could expose them to additional reputational and operational risks, and could change
the general environment in which they do business. Specifically, while companies could see an increase in bad loans,
falling asset values, and more frequent claims on insurance, climate change could also lead to additional regulatory
costs and possibly legal challenges from activists.
There is no time for complacency--over time, climate change may become a material risk factor, particularly for those
financial services companies that haven't already started to prepare for it. Indeed, S&P Global Ratings considers that if
authorities further delay taking the necessary steps to address climate change, the negative long-term effects on
financial services as a whole could be profound.
Despite widespread discussion of the various ways that climate change may affect financial services, it remains difficult
to quantify that impact accurately. However, we are sharing some indicators that we will increasingly use to help us
identify which financial services companies are likely to be hardest-hit by climate change and which are best
positioned to benefit from the opportunities climate change may create.
Overview
Climate change is likely to have uncertain, but considerable, effects on the financial services industry over the
long term.
Reputation, regulation and litigation may represent greater threats than the direct costs of climate change.
The impact of climate change is difficult to quantify based on current disclosures regarding exposure to climate
risks.
Until disclosure improves, we have shared some indicators that help us identify which financial services
companies are likely to be hardest hit by climate change.

Quantifying The Effect Of Climate Change Starts With Good-Quality Data

The various ways climate change may affect financial services have been widely discussed. For example, the Bank of
England recently released a report that identified three main ways climate change could affect insurers--through
physical, transition, and liability risks. The Financial Stability Board (FSB) created a task force on climate-related
financial disclosures. In its Phase 1 report, it classified the risks into six categories. They include two types of physical
risks: acute (driven by extreme weather) and chronic (that is, caused by longer-term changes in precipitation,
temperature, and weather patterns). The other four are nonphysical risks: policy/legal/litigation; technological

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changes; market and economic responses; and reputational considerations.

Despite all the talk, it remains difficult to quantify the potential impact. We consider that, in general, disclosure about
climate-related exposures remains insufficient for an accurate determination. Even where we have enough data, the
complex nature of the risks and uncertainty create significant difficulties in estimating the potential impact. These
uncertainties include how exactly global warming will affect the climate in future, the legal and regulatory changes,
and technological developments that may be introduced to combat the consequences of climate change.
Over time, advances in science and modeling, combined with improved disclosure as a result of initiatives such as that
launched by the FSB, could help us quantify the risks. In the meantime, our analysis looks to incorporate the potential
impact of climate change exposures by considering indicators to help us identify the financial services companies most
threatened by climate change and those that are likely to gain from the new opportunities (see chart).

Changing Attitudes Could Bring New Responsibilities

Initially, the immediate costs of climate change may be low (see "Insurers May Anticipate A Smooth Road Ahead On

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Climate Change-Related Legal And Regulatory Threats Should Spur Financial Service Providers To Action

Climate Change, But Their View Could Be Restricted," published on Nov. 16, 2015, on RatingsDirect). At the same
time, we anticipate that reputational, regulatory, fiscal, and legal risks may present a greater threat in the
short-to-medium term. Those threats, rather than the direct costs, may provide a greater incentive for financial service
providers to better address climate change risks in their operations.
Given the financial sector's role as a key provider of funding to the public and private sector, societies and politicians
may increasingly consider that the sector has a duty to help economies deal with or prevent some of the consequences
of climate change. For example, financial services companies may be expected to provide the financing required for
shifting to a low-carbon economy and building a society that is more resilient to the consequences of global warming.
The financial sector also represents the biggest investors. By encouraging the companies they invest in to improve
their environmental sustainability, they could have a big impact. In particular, they could prompt a shift in attitudes in
those sectors that make the biggest contribution to carbon dioxide emissions and deforestation, such as energy
industries and some agricultural sectors.

Choose to act, or face regulatory pressure

If companies do not choose to fulfil this role, the authorities could come under significant pressure to apply regulatory
and fiscal measures to compel them to act. We would expect these actions to have a negative impact on companies'
business and financial profiles.
In particular, if the future impact of climate change on society proves to be greater than anticipated, authorities may
impose tougher regulatory, tax, and legal changes to enforce reductions in carbon dioxide emissions and investments
in resilience. Such sudden changes may significantly disrupt financial services' operations and affect financial markets.
For example, if authorities introduce or increase green taxes, these could directly increase tax bills at either the
financial service provider or the companies it invests in. It could also cut into the value of their investments and loan
books. It is also possible that regulators could one day introduce higher capital requirements for exposures to polluting
industries or those that emit higher levels of carbon dioxide. We understand that some authorities have also suggested
carrying out stress tests for banks that focus on exposure to climate risks. Although this idea is likely to meet some
resistance, particularly given the number of regulatory reforms already under way, we believe that climate risk
exposure could eventually become a feature of Pillar 2 regulatory requirements for some banks.

Activism and legal pressures

The financial sector may also face reputational risk. For example, financial services companies could become the
target of activist groups if they are seen as supporting companies that emit high levels of carbon dioxide, or are not
perceived to be doing enough to deal with climate change. This may lead to bad publicity, which may damage their
brand name and, subsequently, their competitive positions.
Legal action by communities that have suffered a loss or damage from climate change and are seeking compensation
from those they hold responsible could have a more tangible impact. In some countries, litigation has become a way of
life for financial service providers. The higher-than-expected cost of litigation could affect insurers though the
insurance cover they provide to companies being sued. In addition, all types of financial service providers could be
considered complicit in causing the damage, through their financing role.

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When financial service providers have failed to adequately account for climate change when managing customers'
investment funds, their customers could also choose to bring legal actions. In our view, the legal ramifications of being
indirectly responsible for causing climate issues are highly uncertain. Nevertheless, we expect boards and management
teams to try to avoid the unknown when it comes to legal risk.

The Tangible Financial Impact May Initially Be Low, But Will Grow
We expect banks, insurers, and asset managers to see tangible financial effects from climate change over time.
Restrictions on future carbon dioxide emissions, for example, could mean that the reserves currently allowed for in the
valuations of fossil fuel companies are unlikely to be realized. Once recognized as such, these "stranded" assets would
devalue investments and banks' loan books. Alternatively, new technologies may make traditional industries less
profitable, or even obsolete, hitting the value of companies operating in those industries. For example, the falling cost
of renewable energy technologies could erode the value of investments in fossil fuel facilities. Customers' preferences
could also shift toward more sustainable products, weighing on the valuation of some industries.
If, as many scientists believe, climate change increases the probability and severity of extreme weather events, insurers
may suffer higher-than-previously-expected claims. Insurers would have to allow for these increases in their pricing.
Property investments in high-risk areas could be materially affected in times of severe weather events, if not covered
by adequate insurance. The risk is more pronounced in coastal areas as the impact of coastal flooding will increase as
sea levels rise due to climate change. Banks that are heavily exposed to areas hit by extreme weather may be affected
through a reduction in the value of collateral in their loan portfolio. Borrowers' ability to repay loans may also
deteriorate significantly as a consequence of the event.
Climate patterns are expected to change as a result of global warming. Average temperatures and sea levels will rise,
while drier weather may become more common in some regions. The less favorable climate may harm such regions,
causing business prospects and prospective earnings to deteriorate. For example, if extreme weather is expected to
become a more regular event, the high risk of claims may make it uneconomic to cover a considerable proportion of
previously insured risks.
Business volumes and earnings could fall for banks that rely on the segments of the economy most affected by climate
change. It could also hurt the risk profile of banks that focus on a region where the economy has been damaged by
climate change.

Macroeconomic Changes May Hurt The Most

Climate change could affect the global economy, international political stability, and financial systems in many
different ways. These effects could accumulate, triggering a sharp deterioration in the overall macroeconomic and
financial environment. In such a case, the aggregated cost could be a multiple of the cost directly associated with
climate change.
For example, if stricter carbon dioxide emissions limits are imposed suddenly, the profitability of carbon-intensive

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sectors, and the value of assets in those sectors could immediately see a material deterioration. The effect could
spread to the wider economy and the financial sector, triggering a crisis. The effect would be heightened if a lack of
transparency regarding each bank's exposure to the devalued assets caused a lack of confidence in the financial
system. Such a scenario would be similar to events during the subprime mortgage crisis.
Another scenario could occur if extreme drought led to food and water shortages that affected international stability
and trade. In turn, this could weaken economic prospects and subsequently the valuation of financial services assets,
leading to a financial crisis.
The complex nature of climate change risks means that we can easily create a long list of potential risks to financial
services companies caused by climate change. Inevitably, however, there will always be additional, unanticipated
effects. It is unclear how quickly those risks may emerge. Furthermore, even moderate climate change-related effects
have the power to destabilize vulnerable economies and financial systems.

Despite Everything, Climate Change Also Offers Opportunities

At a time when low interest rates and restrained credit demand are widespread, dampening financial services' earnings
prospects, we consider that financing the low-carbon transition could offer the sector a much-needed sustainable
growth prospect. In 2015, the International Energy Agency estimated that fully implementing the emission reduction
pledges world leaders made to the U.N. would require the energy sector to invest $13.5 trillion in energy efficiency and
low-carbon technologies from 2015 to 2030 ($840 billion a year, on average). We also forecast an increased demand
for financing for green projects and demand from investors for green-focused investment assets. Underwriting these
new types of asset classes will require insurers and banks to develop new modeling and structuring approaches.
However, acquiring the necessary experience and expertise could offer first movers a key competitive advantage.
This year, we expect to see a significant increase in the issuance of green bonds, which are used to fund environmental
projects. We estimate the corporate sector will issue at least $15 billion in green bonds in 2016; a big leap from the
$9.6 billion issued in 2015. Total green bond issuance--including sovereign, financial, and municipal issuance--stood at
$15.71 billion in the first quarter of 2016. Our estimate of full year issuance assumes that corporate bond issues will
continue to make up about 25% of the total deal flow, as was the case in 2015 (see "The Corporate Green Bond Market
Fizzes As The Global Economy Decarbonizes," published on April 15, 2016). Banks which are best positioned to
arrange or underwrite green finance and green investment funds could outpace their peers, especially given the
sluggish growth prospects for banks in many regions.
We anticipate that events we currently assess as tail risks could occur more frequently as a result of climate change.
Financial service providers that take the impact of climate change seriously and incorporate it in their investment and
underwriting decision making processes are likely to materially reduce their exposure to such newly common events.
Although the policy may affect their immediate performance, over time it could improve their investment returns
compared with peers. Offerings from institutional asset managers that develop a recognized expertise in this segment
may also appeal to a growing segment of the investor community, differentiating them from their peers.
We recognize that the industry is not standing idly by. A number of sustainable finance initiatives have emerged,

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including:
The United Nations-sponsored Principles for Responsible Investment. The Principles for Responsible Investment
(PRI) is the leading global investor network promoting responsible investment, which is an approach to investing
that aims to incorporate environmental, social, and governance (ESG) factors into investment decisions to better
manage risk and generate sustainable, long-term returns.
The Montreal Carbon Pledge, supported by PRI. By signing the pledge, investors commit to measure and publicly
disclose the carbon footprint (the total greenhouse gas emissions they cause, directly and indirectly) of their
investment portfolios annually.
Portfolio decarbonization coalition (PDC). All PDC members commit to quantifying their carbon footprint and to
meeting concrete portfolio decarbonization targets (for example, by switching capital to carbon-efficient from
carbon-intensive companies, projects, and technologies within a sector).
The Banking Environment Initiative. Created to encourage the banking industry to act collectively to direct capital
toward environmentally and socially sustainable economic development.
The United Nations Environment Programme Finance Initiative Principles for Sustainable Insurance serve as a
global framework for the insurance industry to address ESG risks and opportunities.
The Geneva Association's Climate Risk Statement. This recognizes the substantial role insurance can play in global
efforts to tackle climate-related risks and aims to coordinate efforts to research and mitigate the effects.
That said, many of these initiatives are still at an early stage and many industry players have not signed them.

Indicators For Measuring Exposure To Climate Change

We expect that, over time, climate change may have the potential to materially affect the credit profiles of some
financial services companies. Direct, indirect, and macroeconomic effects will all contribute to the rating impact (see
appendix for an overview of which elements of the rating analysis of financial services companies could be affected by
climate change). We will use certain indicators to help us determine companies' relative exposure to this risk, to assess
their level of preparedness, and evaluate the risk frameworks they have developed (see table 1). Those indicators cover
the climate change risks which we currently consider most material and for which we can use good proxies from the
best data available, both internally or externally. We recognize that the data may not be fully consistent and accurate.
Over time, we expect disclosure and quantification methods of potential impact of climate change to improve and
provide new insights into financial service providers' risk exposure.
Table 1

Indicators To Help Assess A Company's Risk Exposure To Climate Change

Level Of
Exposure

Metric

Proxy For Climate Change Risk

Risk Type

Fossil fuel companies assets as a proportion of total assets

Exposure to stranded assets

Transition risk

Company
exposure

Average vulnerability to climate change of the countries in

which the company operates

Exposure to acute and chronic weather

Physical exposure

Country
exposure

Revenue arising from agriculture exposures as a proportion

of total revenue

Exposure to chronic weather

Physical exposure

Company
exposure

Capital requirements for insurance exposure to

weather-related catastrophic events as a percentage of total
available capital (for insurers only)

Insurance exposure to acute weather

Physical exposure

Company
exposure

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Climate Change-Related Legal And Regulatory Threats Should Spur Financial Service Providers To Action

Table 1

Indicators To Help Assess A Company's Risk Exposure To Climate Change (cont.)

Risk Type

Level Of
Exposure

Metric

Proxy For Climate Change Risk

Property asssets in coastal areas as a proportion of total

assets

Value of properties exposed to increase in

Physical exposure
the risk of coastal flooding due to the rise in
sea levels

Company
exposure

Average target for reducing carbon dioxide emissions in the

countries where the company operates

Risk of adverse of green tax/regulations

Regulatory/legal

Country
exposure

Carbon footprint of the company, including that of

lending/investments.

Risk of adverse of green tax/regulations

Regulatory/legal

Company
exposure

Litigation culture of countries where the company operates

Litigation risk

Regulatory/legal

Country
exposure

Material noncompliance with major industry

decarbonization/sustainability initiatives

Reputational damage

Reputational risk

Company
exposure

History of bad "green" publicity

Reputational damage

Reputational risk

Company
exposure

Size (by assets)

Reputational damage (we consider that the

bigger the company, the more likely it is
that it could be targeted by activists)

Reputational risk

Company
exposure

Quality of disclosure

Transparency of climate change exposure

All risks

Company
exposure

We will increasingly review the following areas to look for evidence of a higher level of preparedness to deal with the
impact of climate change:

Investments in green energy;

Green credentials, based on ESG statements and climate commitments;
History of supporting sustainability votes at annual general meetings; and
Availability of disclosures supporting low risk exposure.

We recognize that these simple indicators may fail to capture the range and complexity of the ways climate risk may
affect various institutions. However, they can provide useful insights into our analysis of the potential longer-term
impact of climate change on the credit risk of specific companies. We will consider new information and metrics as
they emerge to assess how climate change may affect financial services companies.
We also recognize that future political decisions may determine the speed and method by which financial service
providers are affected by climate change, and which segments or regions will be more vulnerable. For example, if
measures to reduce carbon dioxide are introduced later, the effect on companies exposed to stranded assets will be
delayed and reduced. However, the increased level of carbon dioxide emissions may lead to more extreme weather
patterns, which could hurt other industries, such as agriculture. Financial service providers that have material exposure
to agriculture may suffer.

This Emerging Risk Has Long-Term Implications

We recognize that financial service providers have more-immediate and bigger concerns vying for their attention.
Issues such as regulation, low growth, and the negative interest rates being set in some regions could have significant

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medium-term effects. That said, we consider that climate change risk is only likely to grow in importance and its
potential impact is likely to increase.
The specific effects on each company will depend on the policies and measures taken by governments, combined with
the company's exposure to different risk factors. Depending on the paths the various participants choose to take,
different parts of the financial services sector will be most affected, but the environment in which they operate could
change dramatically.
In our view, providers that start to prepare early for the challenges presented by climate change are likely to be
best-positioned to take advantage of any opportunities that open up. For the others, there could be rating implications
if it is evident to us that a management team is not taking the right steps relative to its peers.

Appendix: How We Capture Climate Change Exposures In Our Rating Analysis

Insurers
Our criteria for determining insurance ratings (see "Insurers: Rating Methodology," published on May 7, 2013)
incorporate our assessments of insurers' business and financial risk profiles. As part of the business risk profile
assessment, we analyze the company's competitive position and the inherent risk of the insurance markets in which
the company it operates, as part of our insurance industry and country risk assessment (IICRA). Climate change could
be a relevant consideration in our assessment of an insurer's competitive position by affecting the strength of the
insurer's brand name and its profitability. Our IICRA incorporates our view of the insurance markets' economic,
political, and financial system risks; its regulatory framework; and its growth prospects--climate change could affect all
of these factors.
Our assessment of an insurer's financial risk profile includes our prospective view of capital adequacy. Applying our
capital model criteria, we incorporate a risk charge to capture the impact of one-in-250-year annual catastrophe losses
(that is, the amount of annual losses that has a probability of 0.4% of being exceeded) in our capital model.
Although climate change may affect the magnitude or frequency of such extreme weather events, there is no scientific
agreement about the precise quantitative impact that the industry could use in its natural catastrophe models. The
uncertainty in an insurer's capital and exposure management relating to catastrophe models could lead us to conclude
that risks are understated in our capital model and weigh on our capital and earnings assessment.
The financial risk profile also incorporates our assessment of the insurer's risk position. Here, we measure risk not
captured in the capital and earnings analysis and risks that could make capital more volatile. If our analysis concluded
that exposure to climate change was material and contributed to above-average volatility in prospective capital
adequacy, this could restrict our risk position assessment.
Our ratings analysis also incorporates our view of an insurer's management and governance and enterprise risk
management. How well insurers prepare themselves to deal with the challenges presented by climate change could be
a relevant consideration in these two assessments.

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Banks
The starting point for our ratings analysis of banks in a given country is the anchor we derive by applying our Banking
Industry Country Risk Assessment (BICRA) methodology (see "Banking Industry Country Risk Assessment
Methodology And Assumptions," published on Nov. 9, 2011). This macro analysis of the economic and industry risk in
a given market could be affected by material systemwide effects related to climate change.
To derive a rating on a specific bank, we then modify the anchor by incorporating our assessments of its business,
capital, and risk profiles (see "Banks: Rating Methodology And Assumptions," published on Nov. 9, 2011). For the
business profile, we analyze a bank's revenue stability and the diversification of its revenue stream. If a bank's business
activities are concentrated in an area or sector we consider could be marred by climate change, this could weaken its
business position and put its rating under pressure. Even if a bank reduces its exposure to climate-sensitive industries,
the pressure on its business position may not ease until it finds an adequate replacement for the lost revenue.
That said, if a bank develops expertise and becomes an industry leader in a climate change-related niche, it could
reinforce its business profile to some extent, by strengthening revenue stability and increasing market share.
We also consider the sustainability of management's strategy. Again, choices made around climate risk exposure could
affect our assessment.
If we anticipate that a bank will suffer losses due to the impact of climate change on its loan and investment portfolios,
we may revise down our risk position assessment. The risk position assessment may also weaken if, in our view, it is
exposed to significant legal risks.
Finally, a bank's capital ratios could also be affected. For example, losses on investments or reserves for loans could
rise significantly due to climate change exposure.

Asset managers
In rating an asset manager, we assess its business and financial risk profiles and combine the two assessments to
derive an anchor. Once the anchor is established, we assess five modifiers: liquidity, capital structure, financial policy,
management and governance, and comparable ratings analysis. These modifiers are applied to the anchor to derive
the stand-alone credit profile and, ultimately, the issuer credit rating (see "Corporate Methodology," published on Nov.
19, 2013 and "Key Credit Factors For Asset Managers," published on Dec. 9, 2014).
We consider that climate change could weigh most heavily on the business risk profiles of asset managers. Investors
are seeking to realize their environmental, social, and governance goals by seeking out new options, such as green
bonds. They are moving their portfolios away from what they deem to be high-risk industries (such as fossil fuel
companies) and toward sustainable and forward-thinking industries.
Asset managers are likely to continue to develop new funds and strategies to capture these investor preferences and
allocate investor money into climate-friendly investments such as wind, solar energy, and other renewable energy
sources. Their effectiveness at doing so could be a differentiating factor, enabling greener asset managers to expand
their asset bases faster than peers that have been less interested or successful in attracting green assets.
That said, we do not think that the impact would be material, unless the new strategy for asset accumulation increased

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concentrations in assets under management.

Related Criteria And Research

Related Criteria

Key Credit Factors For Asset Managers, Dec. 9, 2014

Corporate Methodology, Nov. 19, 2013
Insurers: Rating Methodology, May 7, 2013
Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011
Banks: Rating Methodology And Assumptions, Nov. 9, 2011

Related Research
The Corporate Green Bond Market Fizzes As The Global Economy Decarbonizes, April 15, 2016
Insurers May Anticipate A Smooth Road Ahead On Climate Change, But Their View Could Be Restricted, Nov. 16,
2015
Additional Contacts:
Insurance Ratings Europe; InsuranceInteractive_Europe@standardandpoors.com
Financial Institutions Ratings Europe; FIG_Europe@standardandpoors.com

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