The Financial Conduct Authority (FCA) has warned of “inconsistencies” in the way environmental, social and governance (ESG) issues are considered in credit ratings.
The UK regulator made the observations as part of a wider review into the surveillance, methodologies and internal controls of credit ratings agencies (CRAs).
“We expect CRAs to be transparent in how they consider ESG factors and disclose them in their methodologies and rating actions,” it said, noting there were currently “variations” in how this was undertaken.
“From reviewing files and discussing with firms, we identified inconsistency in how they were classifying and documenting ESG factors,” the FCA added.
“For some CRAs, governance factors were sometimes treated as ESG factors, and at other times considered within broader credit risk analysis. Such inconsistency could reduce clarity for users of credit ratings when reviewing published rating action rationales.”
Applying ESG factors
The paper also observed that CRAs differed in how they applied ESG factors during monitoring and surveillance, adding that some “lacked clarity on the impact and materiality of environmental and social factors in determining a rating action”.
The update comes less than a month after 23 state attorneys general (AGs) from across the US issued a warning to Moody’s, S&P Global Ratings and Fitch Ratings about their approach to ESG.
In letters sent to the three agencies, the AGs alleged that some credit ratings had been downgraded “based on highly speculative ESG predictions and goals”.
It also raised concerns about the potential for fossil fuel-producing states to be downgraded.
Mirroring similar letters sent to investors, insurers, companies and NGOs over the past year, the AGs invoked federal and state-level laws, alleging that the downgrades “violated stated methodologies and reflected undisclosed material conflicts of interest, implicating SEC rules and state consumer protection laws”.
Agencies questioned
All three companies were asked to explain the “specific, quantified financial (not ESG) basis for each maintained downgrade of fossil-fuel companies and states, or reverse all such ESG-driven downgrades”.
In addition, they were told to revise their oil and gas sector methodologies, cutting or limiting the role of transition-risk factors, and cease ESG advisory services – or declare such services as a material conflict of interest.
“Failure to take these corrective actions will inform the undersigned attorneys general’s assessment of whether enforcement action under state UDAP laws, antitrust investigation, referral to the SEC’s Office of Credit Ratings, or coordination with the US Department of Justice is warranted,” the letters said.
The CRAs were also told to stop being signatories to the Principles for Responsible Investment, or disclose membership as another conflict of interest.
Fitch declined to comment on the letter. At the time of writing, Moody’s and S&P had not responded to a request for comment.
