Bridging the sustainable and transition financing gap impacts sovereigns and companies alike. Rahul Ghosh, managing director and global head of sustainable finance at Moody’s Ratings, tells Environmental Finance how greater transparency can help.

Environmental Finance: How is Moody’s Ratings advancing transparency in sustainable and transition finance?

Rahul Ghosh: Moody’s Ratings helps market practitioners assess how material sustainability considerations affect credit risk and capital markets. This has become more important in recent years because of the sheer scale of financing that’s required for the transition to a low-carbon economy. We saw around $2 trillion of energy transition finance last year, but that still leaves an annual gap of $2.4 trillion, or around 1.6% of global GDP, to move towards a net zero pathway by 2030. While this means governments will have to increasingly step up spending – no easy task, given post-pandemic constraints on public balance sheets – scaling private finance will also be crucial.

The debt capital markets will play an important role in addressing the gap, and we expect greater issuance going forward to fund transition assets and activities.

At Moody’s Ratings, we support debt issuers in raising that financing, but also provide investors with the data and insight to inform their decisions on credit portfolio risk management and investment.

We’re also seeing increasing momentum across other sustainable finance themes, such as physical risks, biodiversity, and social investment. For example, using Environmental Finance data, we’ve seen adaptation and nature-related projects in the labelled bond space rise to around 23% of all use of proceeds, up from about 15% at the start of the decade.

EF: How is transition risk shaping global credit quality?

RG: The implications of carbon transition risk for global credit are complex.

We’ve identified 16 sectors with about $5 trillion in Moody’s rated debt with elevated credit exposure to carbon transition. Companies in these sectors, ranging from oil and gas to airlines and steel, will seek to adapt to policy and market changes, decarbonise their operations and supply chains, and invest in green technologies. Many will do so in a way that fortifies their business models and reinforces their credit quality. But others will seek to make those investments amid policy uncertainty, funding constraints, or uncertain returns on emerging technologies, so the risk of capital misallocation is real.

And there will be other challenges along the way. Can power companies meet their decarbonisation pledges in the face of surging demand for energy from data centres? Will policy support for green plans waver as priorities shift or budgets tighten? Given these complexities, investors will increasingly demand that companies articulate well-defined and business-relevant plans to explain how they will achieve decarbonisation and how that will impact their credit quality.

EF: How has Moody’s Ratings developed its sustainable and transition finance solutions and services over the past year?

RG: We serve the needs of the market by providing engagement-led analytics, and research and opinion to show how credit risk and capital markets are affected by sustainability and transition-related considerations. We have constructed a systematic and transparent approach to capturing these risks within our credit analysis and our ratings, including expanding issuer profile scores and credit impact scores to over 12,000 fundamental rated entities and around 3,700 structured finance transactions. This provides greater transparency by allowing investors to identify where potential credit exposures are across portfolios and how that translates into impact on credit ratings.

For the past decade, we’ve also produced annual environmental and social risk sector heat maps, covering 90 sectors and around $84 trillion of Moody’s rated debt. In our latest editions, we found 16 sectors facing ‘high’ or ‘very high’ environmental credit risk, accounting for around $4.3 trillion in rated debt. We also found 21 sectors with $7.9 trillion in rated debt that face heightened credit risk from social factors, such as shifting demographic and societal trends.

We continue to produce thought leadership in the market. Last year we published more than 350 sustainable finance-related reports and hosted 37 events focused on sustainable finance.

EF: What are the features of a high-quality transition plan?

RG: Companies face increasing pressure from investors to provide more granular information around their carbon performance and future targets. Yet, we hear from market participants that data and targets in isolation tell them very little about whether the goals will actually be achieved. That’s one reason we launched our Net Zero Assessment (NZA) to help investors understand the consistency and comparability of targets, and also the soundness of the underlying implementation plans.

Our analysis shows the following common attributes underpin a credible transition plan.

First, the plan is well understood, articulated, and monitored within an organisation. This sounds relatively obvious, but is not always the case. For instance, we look at whether the transition plan is widely known and accepted, shareholder backed and with board-level approval.

Secondly, the plan should be business-relevant. This could lead to meaningful operational efficiencies, cost savings, or the generation of future value by unlocking new revenue streams. Ultimately, companies want to see a return on investment from the capital they’re putting to work to decarbonise.

Finally, the extent to which the plan itself is exposed to external dependencies – for instance, a complex supply chain or regulatory changes, can impact likelihood of success. As countries globally undertake policies to transition to a low-carbon economy, differentiated regional pathways will also become increasingly significant in shaping progress.

Learn how Moody’s Ratings can support your Transition Finance journey.