The Startups Predicting Climate Risk for Bond Investors

The new firms are competing to design algorithms that can predict the likelihood of natural disasters hitting specific towns, industrial parks, even individual buildings, and how much damage they could do. That could become more relevant if wildfires, floods, storms and drought strike more frequently and with greater severity, creating potential new losses for holders of municipal, corporate and mortgage-backed debt.

One company marketing such geospatial data to Wall Street is risQ, a Boston-based firm launched in 2016 by a handful of academics. The firm created a digital grid that divides the U.S. into 100-meter by 100-meter patches of dirt, forecasts the likelihood of climate events in each square and assigns associated risk scores to the bonds that would be affected.

“Eventually this chicken is going to come home to roost,” says the firm’s 34-year-old Chief Executive Evan Kodra, who says he fell into academia after trying to make it as a hip-hop producer in his teens. “It has morphed into a systemic risk that no one person has to worry about when it will hit until it does.”

Climate-risk cartographers are attracting money. Financial-services giant

Intercontinental Exchange Inc.

bought risQ in December for an undisclosed sum and renamed it ICE Data and Innovation Impact Group, though it’s still more widely known by its original name. Credit ratings firm

Moody’s Corp.

has purchased a majority stake in a similar company called Four Twenty Seven Inc., and Sustainalytics, a unit of

Morningstar Inc.,

has started a partnership to assess climate risk in corporate bond markets with a competing firm called XDI.

Geospatial analysis could also help bond buyers better evaluate the credentials of the environmental, social and governance, or ESG, investment products money managers offer them. Greenwashing—or making misleading claims about ESG offerings—by asset managers has become a hot-button issue and the Securities and Exchange Commission proposed new rules in May governing funds marketed with ESG labels.

“Satellite data can provide additional insights to identify property and location intelligence, validate claims and measure impact,” says Andrea Blackman, head of Moody’s ESG Solutions.

Sales have grown slowly for risQ, which the company says is largely because there hasn’t been a big enough climate event—or chain of events—to trigger many bond defaults. Most bond issuers benefit from private insurance and federal and state backstops that help them stay afloat after disasters and many investors don’t see the need to subscribe. Electric utility

PG&E Corp.

sought bankruptcy protection in 2019, in part over fallout over the role its electrical equipment played in sparking California wildfires. But wildfires have yet to force a municipality to default.

That could be about to change. Paradise, Calif., which was ravaged by the 2018 Camp Fire, disclosed in a March regulatory filing that one of its agencies may default on a $4.8 million bond next year. The town received $219 million from a settlement in 2020 but said it plans to use those funds to rebuild infrastructure instead.

Even if only a small fraction of bonds suffer from such an event, collateral damage could be significant. About $4 trillion of municipal bonds are outstanding in the U.S., according to the Municipal Securities Rulemaking Board, as well as $10 trillion of corporate bonds and $12 trillion of mortgage-backed bonds, according to SIFMA.

Should global temperatures rise by three degrees celsius, the yield premium—a risk measure that reflects borrowing costs—could more than double,

MSCI Inc.

said in a November report. Bond prices fall when yields rise. Between 27% and 38% of U.S. companies that have bonds outstanding could lose more than 25% of their market value from physical damage caused by climate events or from new regulations to reduce carbon emission, according to the report.

Mr. Kodra began studying statistics as an undergraduate at the University of Tennessee, Knoxville after his hip-hop dreams fell through. “I found a list of the median salaries for majors in the business program and in mercenary fashion, I picked the highest-paying one,” says Mr. Kodra, who is 6’4” and plays competitive basketball four days a week.

A course in business ethics kindled an interest in climate change that led him to complete a doctorate in interdisciplinary engineering at Northeastern University, where he began researching the increased probability of catastrophic weather events. He wanted to know how long it would take for what was once considered to be a 100-year flood to become a 50-year flood, or even a 20-year flood.

Mr. Kodra created risQ with money from National Science Foundation grants and freelance work in Boston’s startup scene. There he met John Sheffield, a more buttoned-down Harvard University graduate immersed in mapping out vast information troves available in public databases.

Mr. Sheffield joined risQ in 2017 and initially they built a geospatial database for municipal borrowers, ranging from cities and towns to school districts and sewer authorities. The company layered climate data over information like tax revenues, property values, average education, health and income levels.

Evan Kodra was a hip-hop producer before becoming a climate researcher and teaming up with Harvard University graduate John Sheffield. PHOTO ILLUSTRATION BY: AARON DURALL FOR THE WALL STREET JOURNAL(2)

“Before vendors like us appeared, when a hurricane was coming, investors would literally use Google to get the forecasted path of the storm and then eyeball their credits to figure out what was at risk,” Mr. Kodra says.

Over and over, risQ’s model showed that bond markets weren’t discriminating between municipalities with very different climate risk. A school district near California’s wine country has five times the wildfire property-damage risk of a school district a few hours north of Sacramento, for example, but their bonds trade at identical yields, according to risQ research.

Some fund managers subscribed to the product to avoid such pitfalls but many see it as an unnecessary expense. Investors typically rely on their own analysts and outside advice from credit ratings firms like Moody’s and S&P Global Ratings when lending out money in bond markets. Annual subscriptions at risQ cost in the six figures, according to a person familiar with the matter.

“We’ve seen natural disasters shut down local economies…and we’ve never seen a default,” says Robert Amodeo, head of municipals at

Western Asset Management.

Private insurers and payments from the Federal Emergency Management Agency and state funds have kept municipal-bond investors insulated from losses, Mr. Amodeo says.

Sales picked up for risQ last year when the company expanded coverage to include mortgage-backed bonds, using 1.2 billion records culled from various databases, Mr. Sheffield says.

Clients want to know the likelihood of weather destroying the properties linked to bonds they own, which could prompt homeowners to walk away from their loans, he says. They are also worried that creeping climate change will sink home prices as sea levels rise in some places and wildfire seasons expand in others.

The firm, which now has about 30 clients, has also gotten an unexpected boost from fund managers whose clients are demanding proof of ESG impact from their investments. Individuals and institutions increasingly want their investment dollars to drive changes like reduced carbon emissions, lower wealth disparities and improved access to healthcare and education.

“ESG reporting can be challenging, but in risQ’s case it’s a rules-driven approach that is fact-based and analytical,” says Marty Mannion, co-head of automated trading at TD Securities Inc.

After George Floyd’s murder in 2020, money managers began using risQ’s data to identify municipal bonds for them to purchase to promote racial equity, Mr. Kodra says. More recently, some have asked the firm to identify mortgage bonds with higher quotients of homes in low-income areas. Such purchases should drive bond prices up, and yields down, lowering borrowing costs for underbanked communities, Mr. Sheffield says.

“Wildfires, floods and hurricanes do pose a credit risk, but what most people are hoping for when they put their money into ESG products is to make a positive impact,” Mr. Kodra says.

Some envision a time when investors could vet municipal issuers by their progress correcting long-standing racial inequities. The Robert Wood Johnson foundation, a nonprofit focused on health, made a $4 million grant this year funding research and conversations by local government and community leaders on how cities and counties can inform prospective bondholders about their efforts toward racial equality.

Next, risQ is working on a geospatial database of Europe and an eventual expansion to national government-bond markets around the world.

“In the long run we want to give every investor a unified ESG picture of all their assets, regardless of the asset class,” Mr. Sheffield says.

—Heather Gillers

contributed to this article.

Write to Matt Wirz at [email protected]

Corrections & Amplifications
The firm risQ was acquired by Intercontinental Exchange Inc. A previous version of this article incorrectly said it was acquired by International Exchange Inc. (Corrected on July 10.)