The bulk of ESG risk that many companies face stems from shifts in environmental policy and regulation, rather than the direct physical effects of climate change, says Fitch Ratings.
In a new report, the rating agency said that while companies can make investments or other operational changes to mitigate their physical risks, an abrupt policy pivot would be tougher to accommodate.
Companies “are far more vulnerable to sudden changes in ESG-related policies,” Fitch said. “Societal and regulatory pressures could completely eliminate sectors exposed to policy-driven changes.”
The firm said that carbon-intensive sectors are particularly at risk.
“Our analysis pinpoints coal-fired energy as the most exposed form of electricity generation,” Fitch said. “Growing environmental consciousness and the resulting societal and regulatory pressures pose an existential threat to coal-fired electricity generation.”
Natural gas generation is less exposed, but still vulnerable to policy changes.
“Developed markets with mature demand profiles are likely to introduce phase-outs first, resulting in gas generation reaching a moderate to high level of vulnerability in Europe and North America by 2040, while Asia and Latin America are likely to follow this trajectory but with a 10-year lag,” Fitch said.
One area where physical risk may remain more prominent than policy risk is access to clean water.
“Clean-water scarcity is already becoming a major global issue,” Fitch said, noting that around half of the global population already suffers water scarcity issues, and global water demand is expected to grow by between 20% and 30% by 2050.
However, the importance of access to clean water “means that we see the water sector as one of the least vulnerable across the corporate universe even out as far as 2050,” Fitch said.
Water risk “can be overcome by sufficient investment in water treatment, desalination and distribution, and water-efficiency measures, but achieving this requires governments to incentivise water companies to invest in ensuring sufficient water provision,” the rating agency said.