May. 21 2019 —

In S&P Global Ratings' view, the most meaningful rating risks for the telecommunication industry relates to social exposures stemming from consumer behavior, social cohesion and safety management risks. Environmental exposures are lower due to the industry's low direct and indirect use of water and relatively low contribution to greenhouse gas emissions, waste, pollution, and toxicity. Governance-related factors are more company- and region-specific, and primarily relate to jurisdictional uncertainties in emerging markets.

Generally the sector's exposure to social and environmental risks has only a modest impact on our credit analysis. Of the two, social risks are more prominent in our analysis, but the sector is increasing its focus and reporting on environmental risks, which are more quantifiable than other ESG risks. The individual risk factors, associated time scales, and mitigating factors vary by company.

The ESG Risk Atlas

To calibrate the relative ranking of sectors, we use our environmental, social, and governance (ESG) Risk Atlas (see "The ESG Risk Atlas: Sector And Regional Rationales And Scores," published May 13, 2019). The Risk Atlas provides a relative ranking of industries in terms of exposure to environmental and social risks (and opportunities). The sector risk atlas charts (shown below) combine each sector's exposure to environmental and social risks, scoring it on a scale of 1 to 6. A score closer to 1 represents a relatively low exposure, while 6 indicates a high sectorwide exposure to environmental and social risk factors (for details see the Appendix). This report card expands further on the Risk Atlas sector analysis by focusing on the credit-specific impacts, which in turn forms the basis for analyzing the exposures and opportunities of individual companies in the sector.

Social Exposure (Risk Atlas: 4)

Demographic shifts and megatrends like social media and connectivity are key social exposures that affect consumer demand for telecoms. Currently, these factors are shifting demand toward wireless, rather than landline services that offer better utility and personalization, and toward broadband-based over-the-top TV services, rather than traditional cable and satellite video offerings.

Such shifts can test a company's ability to allocate capital and affect return on capital, given the sector's long-lived assets. The ongoing debates over the societal impact of excessive use of social media, particularly among younger users, and the effect of misinformation in the media could create social pressure to reduce or change usage patterns.

Any incidents related to data security and systems stability in the telecoms sector will also be highly visible, given the sector's extensive reach. Thus, security concerns over an equipment supplier, for example, could trigger a shift in public perception, or an outright regulatory ban. Such a ban would weigh on pricing and could cause delays to network projects. Loss of access to a supplier's technology could also affect service quality and may require the costly and disruptive replacement of equipment. If a company suffers an actual network security breach, it can have even more dire reputational and regulatory consequences.

In assessing social risk, we consider public confidence in operators on community engagement, equity, and corporate citizenship. Given the sector's large and ethnically diverse customer base, community relationships and sensitivity form low, but important social cohesion risks.

Telecom companies also typically have large workforces that are significantly unionized. This makes human capital management another key social risk. The industry's technicians are associated with safety management risks, as are the personnel that build and maintain the telecom infrastructure, including towers and data centers. Another nascent, but notable, social risk stems from potential health concerns regarding exposure to electromagnetic frequency (EMF) radiation from high-frequency fifth-generation (5G) telecom equipment and devices. This could affect consumer perception and usage of telecom services.

Environmental Exposure (Risk Atlas: 2)

The telecom sector's use of energy to power its communication networks, data centers, and operations (such as truck rolls, IT systems, call centers, points of distribution, and IT systems) is less intensive than utilities or natural resource sectors. It therefore makes a relatively moderate contribution to greenhouse gas emissions.

That said, the sector has turned its attention to increasing its energy efficiency and we have begun to see telecoms companies like Telefonica and Verizon issuing green bonds. Fiber to the home (FTTH) is 85% more energy-efficient than copper networks because it reduces the need for cooling systems and the number of central offices. We expect to see companies deploying FTTH more widely, which will help to achieve energy reduction targets.

Exposure to climate change risks is modest and largely based on the effect extreme weather such as hurricanes, tornadoes, ice storms or flooding would have on telecoms operating infrastructure and customers. We classify the perceived health risks of EMF radiation as a social exposure, pending further studies. Should health risks turn out to be justified, we could also consider the radiation exposure as an environmental risk in our ratings, similar to other forms of pollution.

Governance Exposure

Governance-related factors are typically more company- and region-specific. Most are related to jurisdictional uncertainties in emerging markets. This can lead to regulatory and litigation risk. In addition, operational frameworks--for example, those used to run spectrum auctions--may be unpredictable, resulting in unexpected outcomes, or delayed decisions.

In some instances, government regulation can itself affect operations--for example, restrictions on the use of VOIP services can have clear implications for data usage and, ultimately, revenue potential.

In some countries, the government views telecom operators as proving a service, more like a public utility. Operators may be subject to service obligations that affect capital expenditure and return on capital. For example, they may have an obligation to build a physical network in rural areas.