ESG factors can impact sovereign credit quality negatively, especially when governance is an issue, according to a Moody's Investors Service report released Tuesday.
Two new Moody's scores for all rated sovereigns — issuer profile scores and credit impact scores — measure their exposure to ESG factors and the effect of ESG on credit ratings, respectively.
Marie Diron, Moody's managing director of sovereign risk and the report's co-author, said the scores highlight the relative vulnerability of sovereigns to climate change, water risk or carbon transition, demographics, income inequality and other ESG factors. "They also highlight the credit impact of governance strength and generally the varied capacity of sovereigns to respond to ESG risks," Ms. Diron said in a statement.
According to the report, environmental risk is most often moderately negative and neutral at best, while social risk tends to be moderately or highly negative. For most advanced economies, governance is a positive factor, while it varies for emerging markets.
Sovereigns facing a negative ESG impact include South Africa for its social risk, Bangladesh for environmental and social risk and Turkey with "increasingly weak governance" impacting its sovereign rating, the report said.
The 11 countries where ESG factors have an overall credit-positive impact illustrate the benefits of strong governance and limited exposure to environmental and social risk, Moody's found.
Environmental risk is most often negative or neutral at best, according to the report, and 40% of emerging markets have highly negative exposure to climate or water risk and in some cases carbon transition. Social risk tends to be moderately or highly negative, Moody's said.
