S&P Global Ratings is taking steps to clarify how environmental, social and corporate governance (ESG) considerations feed into its credit analysis.

The credit rating agency is phasing in the incorporation of ESG sections in its corporate rating reports. It started doing so for the oil and gas and utilities sectors and is now rolling this out to all major companies across every sector, and to smaller companies in the sectors most exposed to ESG factors that may be relevant to ratings.

It expected around 40% of the corporates it rates to be covered by an ESG section by the end of the year, it indicated. 

According to the Principles for Responsible Investment (PRI), credit rating agencies needed to explicitly signpost credit-relevant ESG risks and opportunities in rating reports.

The PRI has been working with credit rating agencies and investors since 2016 in a bid to improve consideration of ESG factors in credit risk analysis and promote better understanding of the practice.

The PRI found that some “disconnects” between fixed income investors and credit rating agencies were due to a lack of investor awareness of agencies’ improved ESG-related focus and analytical resources. They could also be misconceptions linked to the two groups’ different objectives, PRI said. 

Michael Wilkins, managing director and head of sustainable finance at S&P Global Ratings, said: “We have long incorporated ESG considerations into our credit analysis. What we aim to do now is to more clearly underline to industry bodies, investors, and stakeholders how we do so.”

Michael Wilkins S&P

Michael Wilkins, S&P

In a report rounding off the first phase of the ESG and credit risk initiative, the PRI said progress had been “remarkable”, especially by the large credit rating agencies.

Carmen Nuzzo, PRI senior consultant on the initiative, said the largest agencies had “embarked on a race to the top”.

Last month Fitch launched ESG “relevance scores” to show how ESG factors affected the agency’s individual credit rating decisions.

Moody’s has also taken steps to be more clear about how it incorporates ESG issues into ratings. In November 2017 it announced it had expanded its ESG-dedicated teams and resources as part of this effort.

Work in progress

My-Linh Ngo, head of ESG investment risk at BlueBay Asset Management and chair of the PRI advisory committee on credit ratings, said: “This PRI-led initiative has been instrumental in advancing thinking and practice in terms of incorporating ESG into debt investing.

“With the growing momentum and engagement from the industry, we are very excited about the next phase.”

This next stage would include extending the initiative to include bond issuers, the PRI indicated, with a view to advancing understanding of the materiality of ESG factors to credit risk, as well as promoting engagement, developing common terminology, and enhancing data disclosure.

Nuzzo said more work was needed to assess the link between sustainability and credit quality.

The PRI has compiled a list of recommendations to improve the process and output of ESG consideration in credit risk analysis, targeting investors and credit rating agencies.

Recommendations for investors included that they set up internal frameworks to make ESG consideration more systematic and “not confuse the purpose of credit ratings and ESG assessment services”.

Steps that both groups needed to take included to: 

  • categorise ESG factors by type, relevance and urgency;
  • conduct regular retrospective analysis to assess how their relevance evolves;
  • use sector, scenario, sensitivity and stress-testing analysis to monitor long-term risks, incorporate uncertainty and focus on drivers of potential outcomes; and
  • engage with issuers on ESG topics to improve awareness, disclosure and transparency.

The PRI said some “advanced investors” had made visible progress on many aspects of the recommendations, which were intended to be treated as best-in-class practice rather than a one-size-fits-all approach.