European Central Bank working paper links sovereign credit ratings to physical climate risk and finds stronger post Paris Agreement signals on transition risk

The European Central Bank published a working paper assessing whether major credit rating agencies systematically incorporate physical and transition climate risks into sovereign credit ratings. Using a multi-country panel over two decades, the authors find that physical risk indicators are associated with weaker sovereign ratings, while transition risk metrics are generally not reflected across the full sample period, with more evidence of post-2015 differentiation. Based on ratings from Standard & Poor’s, Moody’s, Fitch Ratings and DBRS Morningstar for 124 countries (1999–2021), higher temperature anomalies and more frequent natural disasters are associated with lower ratings, and higher “readiness” scores are associated with higher ratings, though the paper notes the overall economic contribution of physical-risk variables is modest relative to standard macro-fiscal determinants. For transition risk, measures such as emissions intensity, energy intensity and CO2-reduction targets are not systematically significant over the full sample, but difference-in-differences tests using the Paris Agreement as a breakpoint suggest increased agency attention after 2015: disaster-exposed countries receive comparatively lower ratings, while (for transition-risk-exposed countries) more ambitious CO2 targets and falling CO2 emissions intensity are associated with higher ratings. The paper also finds that, after 2015, higher sovereign debt and greater reliance on fossil fuel revenues coincide with lower ratings, while revenues from transition-critical materials are associated with higher ratings.