Introduction

In May 2016, the ESG in Credit Ratings Statement was launched for investors and CRAs to publicly state their recognition of the value of considering ESG factors transparently and systematically in credit risk analysis. The statement is still open to sign and its roster of signatories is expanding rapidly.

The ACCR was formed in late 2016. Under its guidance, another milestone was reached in July 2017 with the publication of Shifting perceptions: ESG, credit risk and ratings – part 1: the state of play.

Based on the findings from stakeholder interviews, the PRI Reporting Framework data, investor survey and research review, part one concluded that ESG consideration in credit risk is still incipient or limited for most market players. However, the report found that efforts are gaining traction, with investors and CRAs beginning to expand resources including towards human capital. It highlighted the drivers of stewardship such as climate change and corporate scandals which contributed to the global financial crisis, as well rising investor demand for ESG-linked assets.

Intensifying regulatory focus

The PRI was among the first organisations to recognise the importance of engaging with CRAs and investors to advance understanding of the impact of ESG factors on credit risk assessment, improve risk-adjusted capital allocation and promote sustainable investing. More recently, regulatory pressures have also been building up in Europe: the EU High-Level Expert Group on Sustainable Finance featured a section on credit rating and sustainability rating agencies, and provided recommendations for the subsequent EU Commission Action Plan, published in March 2018.

The EU Commission is now taking time to assess current practices and plans to engage with all relevant stakeholders to explore the merits of amending the Credit Rating Agency Regulation. It has charged the European Securities and Markets Authority (ESMA) with the task of assessing current practices in the credit rating market and of including environmental and social sustainability information in its guidance on disclosure for CRAs. Finally, it has commissioned a comprehensive study on sustainability ratings and research. The exploratory period that the Commission has set itself before introducing concrete steps will hopefully highlight the changes that stakeholders are embracing, including those that the PRI is catalysing through the ESG in Credit Ratings Initiative.

Nurturing investor-CRA dialogue

Despite highlighting encouraging progress, part one concluded that ESG consideration by credit practitioners is still far from systematic and that communication must improve further. Part two aims to test those findings from a wider CRA and investor sample compared to that which was used previously.

It also comes as the need to better assess credit risk in line with fundamentals is intensifying with the ongoing unwinding of quantitative monetary policy easing (QE) in several large countries. Yields are normalising after an unprecedented compression which boosted risk appetite and demand for high-yield (low credit-rated) investments in search for income. As a result, the case to identify red flags to price risks more adequately has become more compelling.

Specifically, this report is based on:

• PRI forums for credit practitioners: these events were a unique opportunity to engage a wider and more credit risk-focused audience of investor and CRA professionals;
• responses from a PRI survey taken by investor attendees: please click her e for the full results; and
• case studies: these were provided by participants during or after the events and give examples of recent progress, as well the challenges at stake.

The PRI forums

• Location: the PRI organised 11 events in Western Europe, North America and Australia between September 2017 and February 2018.
• Format: almost all the forums were in a roundtable format to facilitate group discussions, preceded by a short introduction on the ESG in Credit Ratings Initiative and a presentation by CRA representatives to bring investors up to speed on the latest developments.
• Participants: the number of attendees was limited to 20-30 to facilitate active participation. Most were senior credit analysts and FI portfolio managers, and a small number of ESG analysts. They primarily belonged to AMs (although in some events AOs also participated). CRA representatives were senior credit officers, criteria officers or heads of research departments.
• Focus: with the exception of the Berlin, London and Paris events, where sovereign credit risk was considered, the focus of the sessions was on corporate credit risk. This was because it was not possible to have corporate and sovereign CRA officers at all events. However, we plan to revisit sovereign credit risk in more depth, and consider its links with corporate credit risk. Indeed, the topic generated significant interest.
• Chatham House Rule: quotes and comments cited in this report have not been attributed to specific individuals or organisations.