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S&P to Spotlight ESG Risk in Corporate Debt

SS&P Global Ratings will add a new emphasis on environmental, social and governance (ESG) evaluations of corporations within its issuer credit rating reports. “What we are doing is making it easier for a reader [of our reports] to find any credit-related ESG factors that are driving the credit rating,” said Nicole Martin, senior director, sustainable finance, at S&P.  “It’s for the ease of readership and better transparency, but in terms of our criteria there is no change,” Martin noted. “We always considered all factors that could affect credit.” 

Nicole Martin, senior director, sustainable finance, at S&P.

Last fall, S&P published a “look back” on social issues and governance issues, which reviewed how often those issues were mentioned in the rating agency’s reports from 2013 to 2015 and from 2015 to 2017. What it found was that the number of instances where it mentioned ESG or climate in its analysis of corporate-rated entities as being important to a credit doubled between the two periods. “It is only on two data points, but it is an interesting observation, Martin said. She highlighted the fact that “often ESG factors can enhance a credit rating. It is not always a negative to credit quality, so the look-back study also gives information on the status of when it contributes to a change in an outlook, or a positive versus negative change,” she said.

The firm expects to put its new analysis into 2000 credits throughout the course of the year, which makes up about 40% of the rated corporates in the S&P universe.  “If it’s material, we will include it in the rest of the companies, although in some companies, governance already contributes to the rating,” Martin said. “The assessment is part of our criteria, but ESG factors may or may not have a material effect on our credit rating, so those may not be a paragraph [in the report],” she said. “But there could be an event in which it would mean there was a social issue that was important to credit and then we would include it in the rating action,” she said. 

Investor response

“S&P’s announcement means fixed income and other investment managers will have a stronger and more complete sense of risks. It’s exciting news – and we’re looking forward to how this will elevate ESG conversations in the future,” said Michael Garland, director of corporate governance at the NYC Comptroller’s Office.

S&P has been conducting outreach for many years on ESG. But of late, “this has become a much more topical issue and investors are asking for the information. They are taking it into consideration in their investment decisions, according to several surveys that have been executed over the years. The results show that there is an increasing appetite from pension funds and investors to get more transparency in this space,” Martin said.

 “Many of the investors we speak with echoed the same sentiments,” said Mike Ferguson, director at S&P Global, in the U.S. Energy Infrastructure Group, in a vide posted on the S&P’s website. “ESG risk can be meaningful to credit; while our methodology has always captured ESG risk factors that have been considered material to credit quality, the credit risk can be captured in a variety of different ways,” he added. “I’d say there is a likelihood that these risks are going to evolve over time, especially with the changes in the regulations and changes in the climate.” 

UN Principles for Responsible Investment

The move by S&P to focus its ratings more on ESG factors coincides with the publication of the UN Principles for Responsible Investment (UNPRI)’s third installment of its Shifting Perceptions: ESG, Credit Risk and Ratings report series, which recommends that credit rating agencies (CRAs) explicitly signpost credit-relevant ESG risks and opportunities in rating reports.

The ESG analysis will also make governance more explicitly part of its rating criteria than before. “We look at governance scores on a stand-alone basis, and we score them from strong to weak,” Ferguson said in the video. “Companies that have boards that are not that independent or have had managers that have a misalignment of incentives–those could have scores that are weak, and if that is the case that can drive a rating lower,” he noted. 

Emphasis on how ESG ratings work

S&P produced separate sections of its reports this past summer and fall that include analysis of all its “high profile” issuers. It will follow up with reports on all its issuers to “evidence the ESG risk factors that will be materially impactful to credit quality.” Research updates will also be added to the reports to discuss any changes in ratings that are driven by ESG risk. The agency will additionally issue industry report cards, with trends in multiple company analysis for the same industry.

The S&P reports also highlight variations between the environmental, social and governance factors. For instance, while environmental factors were split evenly between having negative and positive risk, social risk factors were generally negative. “Governance risk factors were also generally negative, and in some cases resulted in multiple notch downgrades, so, certainly, these will be considered material for credit quality,” Ferguson said.

Utility & Retail Companies

Ferguson cited utility companies as an example of companies that could be most at risk to a change in rating due to ESG factors. A utility company may have had significant exposure to carbon, whether through coal or gas or fire generation, Ferguson noted. Therefore, the company “might, over time, be exposed to a carbon tax in which case its financial metrics could weaken,” he explained.

Retail companies are another example of the type of company that could be at high risk of receiving a lower credit rating, due to ESG factors. For retail companies “brand is very important,” Ferguson said. If it [the retail company] had a significant public or social controversy it could weaken its business risk profile, and its competitive position could weaken over time,” he explained.

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