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US state, local governments warned to brace for climate shocks

Global credit rating agency, Moody’s Investor Services, has released a new report describing the importance of measures to reduce greenhouse gas emissions and build resilience to the inevitable impacts of climate change in order to avoid negative credit ratings. The findings are relevant for states and municipalities in the United States.

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Donald Trump, US president

The US is still recovering from the devastating impacts of severe hurricanes such as Irma, Maria and Harvey that caused a widespread destruction of lives and livelihoods, and damaged properties and infrastructure of billions of dollars.

The report “Environmental Risks – Evaluating the impact of climate change on US state and local issuers,” forecasts that the accelerating impacts of climate change, including increasing global temperatures and rising sea levels, will make an impact on the financial health of US states and municipalities in the years ahead. Moody’s assigns credit ratings to bond issuers to indicate the risk of default.

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“While we anticipate states and municipalities will adopt mitigation strategies for extreme climate events, costs to employ them could also become an ongoing credit challenge. Our analysis of economic strength and diversity, access to liquidity and levers to raise additional revenues are also key to our assessment of climate risks as is evaluating asset management and governance,” Michael Wertz, Moody’s Vice President, said.

The frequency and intensity of extreme weather events – natural disasters, floods, heatwaves and droughts – is likely to increase with the rise in global average temperature. Recognising the importance of mitigation (reducing greenhouse gases) and adaptation (building resilience) strategies to avoid the worst impacts of climate change, the Paris Agreement aims to limit the average global temperature rise well below two degrees Celsius and as close as possible to 1.5 degrees.

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Differentiating between climate shocks and long-term climate shifts

The Moody’s report makes a distinction between climate trends – long term shifts in the climate over several decades – and climate shocks, defined as extreme weather events exacerbated by climate trends.

Extreme weather events make significant impacts on an issuer’s infrastructure, economy and revenue base, and environment. The report explains how the credit agency factors these impacts into its analysis of an issuer’s economy, fiscal position and capital infrastructure, as well as management’s ability to marshal resources and implement strategies to drive recovery.

One example of climate shock driving rating change was when Hurricane Katrina stuck the city of New Orleans (rating: A3 Stable). In addition to widespread infrastructure damage, the city’s revenue declined significantly and a large percentage of its population permanently left New Orleans.

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For issuers, the availability of state and federal resources is a key element that improves the response capabilities of local governments and their ability of mitigate credit impacts. Moody’s analysis weighs the impact of climate risks with states and municipalities’ preparedness and planning for these changes while analyzing credit ratings.

Analysts for municipal issuers with higher exposure to climate risks will also focus on current and future mitigation steps and how these steps will impact the issuer’s overall profile when assigning ratings.

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