Prime climate risk ratings

Provide a short overview of the research innovation being proposed for the award

Fixed income is the world’s largest asset class. In 2017, Insight Investment created the first climate risk assessment of fixed income corporate bond issuers aligned with the Task Force on Climate-related Financial Disclosures (TCFD). Its new Prime climate risk ratings, launched in 2021, collects information from 1,700 issuers of corporate debt, covering 200 metrics and 14 climate-related themes, and generates multiple rating signals. Insight believes this makes it the most extensive and detailed evaluation of fixed income corporate issuers’ physical and transition climate risks.

The Prime climate risk ratings support portfolio construction and investment decision-making, allowing users to:

• Pursue climate risk strategies without simplistic sector-based exclusions that do not distinguish between leaders and laggards;
• Isolate company weaknesses and use the information to support engagement and monitoring;
• More accurately identify the worst-performing issuers and actively screen them from investment portfolios;
• Consider material climate risks and build dedicated strategies; and
• Visualise company risks using detailed company maps and rating assessments.

Provide a description of the research innovation or report your organisation has introduced or published, and why you decided to undertake this approach

The Prime climate risk ratings expand upon the principles of the TCFD, set up in 2015 by the Financial Stability Board to develop voluntary and consistent financial climate risk disclosures. The Prime climate risk model analyses and quantifies the investment risk due to climate change for more than 1,700 credit issuers. Its methodology harnesses information sourced from direct company responses, open-source data and third-party data providers, before overlaying sector and location-adjusted weightings to give an overall climate risk measure. The model encompasses both transitional and physical risk factors within its framework and is paired with a broad-based dataset designed to inform investment decision-making and guide portfolio construction.

Climate modelling in fixed income is critical to ensure investment portfolios more accurately and reliably reflect the climate risks that companies face. Aligning with the principles behind TCFD, the Prime ratings include forward-looking scenario analysis, which in turn rests on key performance indicators Insight has curated, weighted and scored. The Prime climate risk ratings create two scores for each company: one each for its transitional and physical risks. Multiple scores help to prioritise risk analysis and the investment process. Each key issue, theme and pillar is independently evaluated to support a more complete interrogation of company performance and to enable comparison with peers.

Insight has gone beyond restructuring and enhancing its climate methodology. The company has complemented the data modelling with several interactive dashboards that visualise climate data and more effectively compare performance.

The challenge facing investors is managing the plethora of data and prioritising amongst the noise created by model outputs and their inputs. Insight has introduced a system to avoid black-box analysis. A physical risk analysis page can review company assets against fire, water, flood, heatwave and hurricane climate issues.

Meanwhile, the Prime climate risk ratings more accurately and reliably reflect the transition risks companies face by appraising them against their climate metrics and overall governance. The analysis can help analysts efficiently identify laggard issuers and why they are flagged.

Climate change is the most critical sustainability challenge, and Insight believes more informed analysis will support investment portfolios over the long term. The extensive ratings and modelling system deployed, complemented with data analytics, demonstrate that climate analysis for fixed income is not only practical, but has tangible benefits to portfolio construction, stewardship and investment processes.

Outcomes, benefits, challenges and next steps: provide an outline as to:

• why you believe the report, process or approach is different and the aspects you believe are innovative;
• the value this approach has provided or a summary of the key conclusions;
• what you have you learned from this approach or report that can be applied more broadly.

Within fixed income, default risk is the prism through which Insight’s credit analysts consider every issue; climate risks are a necessary element in determining the relative risk of default loss. For active fixed income portfolios without explicit investment criteria linked to climate change, climate risk is a material but not central risk factor in most sectors. However, for portfolios with a longer-term time horizon, such as strategic credit portfolios, and for portfolios with explicit sustainability and climate change investment criteria, a more advanced assessment of climate risk can shape better portfolio allocations. For bond issuers with meaningful climate impacts, Insight uses the climate risk ratings to understand their risks and how they are managed; engagement with such companies can play an important role in helping its analysts monitor and challenge climate activity (or inactivity).

Prime can also help Insight’s ESG team identify potential issues that need to be accelerated and the companies where there is existing bond exposure but inadequate demonstration of climate management.

Insight’s experience suggests that all companies manage climate issues in different ways. The investment winners and losers from the climate transition are unknown, with company strategies at a nascent stage. Excluding entire sectors is not in clients’ interest – the sectors with the greatest climate impacts are also amongst the largest issuers of debt securities. A more intelligent way of responding to climate change is required, and the sophisticated management of data, combining millions of data points to appraise issuers, is the most advanced way investors have today to systematically manage the issue. Advanced modelling techniques are critical to deliver the right signals to guide investment analysis.

However, ratings are not enough. Insight’s innovation has been to use the data inputs and model outputs to create highly useful and adaptive dashboards to guide the investment team. This puts a marker down for the responsible investment community: it is not enough to have proprietary scores – they must be useful and open to scrutiny. One of the principal criticisms of external ratings, especially climate ones, is that they are a black box, where no investment analyst can be sure how or why a company scores in a certain way. Insight’s methodology can show precisely why a company is a climate leader and how laggards can improve their performance.

When Insight introduced its climate ratings in 2017, the use-case was basic: it supported select engagement priorities. Today, advanced modelling and credible outcomes has meant it has the broad support of the investment team and is actively used to support portfolios. This has had tangible results that go beyond initial expectations. For example, select issuers have been sold from portfolios for having the lowest climate risk rating and others have been identified for engagement. This shows that innovative climate tools do not have to sit in a silo – they can and should be part of the investment process.

The value of Insight’s approach includes:

• Independent thinking on how climate issues impact sectors;
• Objective analytics that use quantitative inputs that avoid having to make moral decisions;
• Transparency over company behaviour and what is driving performance;
• Adaptability to change as data improves and companies act;
• Incorporation of broad data inputs to capture multiple perspectives; and
• Providing a complement to investment processes, neatly fitting into credit research notes and engagement priorities.