PRI publishes new report on ESG factors in credit risk analysis

With funding from the Rockefeller Foundation, Shifting perceptions: ESG, credit risk and ratings – part 1: the state of play looks at why ESG factors matter in credit risk analysis, what investors and CRAs are currently doing on this front, and what their expectations are.

The report highlights several disconnects between investors and CRAs, particularly regarding views on which time horizons to consider. It also raises questions related to the role of regulators, products that complement traditional credit rating tools, and how credit analysts can be incentivised to incorporate ESG factors more systematically in their analysis.

“The dial is definitely beginning to move in the right direction, but we are not at a stage yet where ESG factors are systematically included in credit risk analysis.

“ESG integration is still perceived as a ‘nice-to-have’ rather than a ‘must-have’,” said Carmen Nuzzo, PRI Senior Consultant, Credit Ratings Initiative.

Highlights from the report include:

• Investors and CRAs are ramping up efforts to consider ESG factors in credit risk analysis. Resource allocation is clearly increasing with research mostly focused on environmental issues. However, ESG integration is not yet systematic.
• Investors’ and CRAs’ views on the visibility and materiality of ESG factors vary, partly because they look at credit risk from different perspectives.
• CRAs already consider many ESG factors in credit rating analysis, but must communicate this better. Expertise in this field is improving but it is still hard to demonstrate that ESG consideration is prompting changes to credit rating outcomes; while some evidence is emerging, it is still patchy.
• On the investor side, ESG analysis is not consistently taken into account in credit risk assessment; often it is advisory in nature and securing internal investment buy-in for ESG consideration is still a work in progress.

“Considering ESG factors in credit risk analysis – in addition to traditional financial drivers – is critical to inform fixed income investment decisions. Investors start to appreciate that it is not only growth that matters, but sustainable growth, and that’s what ESG consideration is about.”

My-Linh Ngo of BlueBay AM and Ole Hagen Jørgensen of Global Evolution, co-chairs of the PRI’s Advisory Committee on Credit Ratings.

The report highlights several disconnects between investors and CRAs, as they consider credit risk from different perspectives. The relevant time horizon over which ESG factors are deemed material is one of the most contentious point.

“S&P Global Ratings has long incorporated ESG factors into our processes, and to further complement these efforts we are establishing new ESG teams and are participating in industry-wide working groups that research, analyse and engage on ESG topics. We believe our relationship with PRI and the development of new evaluation tools will lead to more substantial insights on emerging ESG issues over the medium and long term.”

Yann Le Pallec, Head of S&P Global Ratings Services.

Shifting perceptions: ESG, credit risk and ratings – part 1: the state of play plants the seeds for more work ahead, including forums that the PRI will organise over the coming year to facilitate investor-CRA dialogue.

“The PRI’s report advances the goal of developing a market dialogue to ensure the transparent consideration of ESG factors in the assessment of creditworthiness. Moody’s, a signatory to the ESG in Credit Ratings Statement, incorporates evaluations of all relevant and material factors that could affect an issuer’s ability to repay its debt obligations – including assessment of ESG factors.”

Jim Hempstead, Managing Director, Moody’s Investors Service.

The report raises questions related to the role of regulators, products that complement traditional credit rating tools, and how credit analysts can be incentivised to incorporate ESG factors more systematically in their analysis.

“We are glad to be able to participate in the thought leadership for this landmark PRI publication, which deepens the understanding of ESG analysis in credit assessment for both investors and CRAs.”

Foo Su Yin, CEO of RAM Ratings.

To date, 120 investors have signed the ESG Credit Ratings Statement (representing US$19trn of assets under management), as well as nine CRAs. The statement remains open to new investor and CRA signatories. All signatories are welcome to participate in the rating forums and dedicated working groups which the PRI will organise over the next year.