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Environmental, social and governance risks influence sovereign ratings

Moody’s conclusions are included in its just-released report “Sovereigns — Global: Environmental, social and governance risks influence sovereign ratings in multiple ways”

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Moody’s Investors Service says that changing environmental, social and governance considerations can affect sovereign ratings.

“Such considerations — commonly referred to as environmental, social and governance (ESG) risks — have become of increasing importance to investors over the last several years, and Moody’s has a long track record of assessing these considerations, focusing on their impact on a government’s ability to make debt payments,” says Gabriel Torres, a Vice President Senior Credit Office in Moody’s Sovereign Group.

“Certain ESG risks are already captured directly as indicators in our sovereign rating methodology, while others influence subfactors and indicators that support our credit analysis,” adds Torres. “At the same time, we acknowledge that it is rarely possible to identify the precise impact of such risks on a particular sovereign’s rating.”

Moody’s conclusions are included in its just-released report “Sovereigns — Global: Environmental, social and governance risks influence sovereign ratings in multiple ways”.

Moody’s report points out that, while ESG is often spoken of as a single, homogeneous category of risk and while the three overlap in some respects, they are also quite distinct from one another.

Accordingly, it is important to appreciate their distinctness if they themselves are to be properly understood, and measures to address each are to be properly assessed.

Of the three E, S and G risks, G has the strongest quantitative relationship with both sovereign ratings and Moody’s four methodology factors: economic strength, institutional strength, government fiscal strength, and susceptibility to event risk.

Specifically, Moody’s assessment of institutional strength includes measures of government effectiveness, rule of law, and control of corruption.

Governance risks are also relevant to Moody’s assessment or political risk, since weak governance raises the risk that political tensions or conflict have an impact on a country’s economy or public finances.

Meanwhile, both E and S can influence Moody’s assessment of economic, institutional and, to a lesser extent, fiscal strength.

Environmental credit considerations relate to the physical conditions in which societies operate, both at present and in the future. The latter draws in the impact of climate changes, as well as the global transition to less carbon-intensive economic development.

And social considerations encompass threats to a sovereign’s credit profile that derive from society’s characteristics and structure. Such considerations include, among others, the fiscal, economic and political implications of social conditions such as poverty, inequality or violence and crime.

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