Capital Markets are enjoying a wide array of new players. Investors, companies, credit rating agencies and sustainability rating agencies are increasingly focusing on the ESG (Environmental, Social and Governance) issues. ESG Ratings lack of regulation is a current theme for the ESMA, whose Chairman said that the Authority is going to fill this gap: “Personally I believe that, where ESG ratings are used for investment purposes, ESG rating agencies should be regulated and supervised appropriately by public sector authorities”. [1]. This topic is to be announced due to its actuality for the present and its relevance for the future. But our object is to focus in the shoes of credit rating agencies (CRAs).
The fact that investors and companies have been playing an increasing role in putting ESG at the core of their agenda is no novelty. However, the role of CRAs in this area corresponds to a set of vexed questions: in how far can a Credit Rating Agency take into account ESG criteria? Can a Credit Rating Agency issue an ESG rating? Could CRAs take over ESG Rating Agencies?
A keynote UN Finance initiative document [2] addresses the first question. Put bluntly, the UN did report that CRAs are considering all the factors related to creditworthiness in their assessment, including a set of specific ESG factors depending on the company industry. Nevertheless, those selected ESG factors are a praxis, rather than a methodology. ESG criteria has something to say on creditworthiness to the extent for which the Market appreciates worldwide Climate Change Policies. Given Capital Markets focus on ESG and Sustainability, the use of some specific ESG factors in credit rating assessments will become thus informally binding; but as a matter of fact, CRAs will keep their keynote role of assessing credit issues and not ESG performances. Therefore, in the credit rating assessment, ESG factors are not pivotal to creditworthiness, but rather ancillary – as remarked by a banking expert from ING Banking Group [3].
A further consideration can follow suit: ESG and creditworthiness can pair themselves only a posteriori, when the evaluation has already been disclosed. In fact, a full investment grade on credit does not mechanically correspond to a full investment grade on a green portfolio. As a leading Sustainable Finance Analyst from Fitch pointed out: “If an issuer's activity was ESG 'friendly' it did not necessarily mean that it would convey a credit benefit” [4]. An equivalent but straightforward statement in this sense came from Standard&Poors, whose spokesperson announced: “Our ratings are an opinion of creditworthiness. Potential rating factors--including ESG credit factors--are considered if we believe they may affect creditworthiness” [5].
Furthermore, a recent ESMA pronunciation [6], warned the Market about the lack of uniformity on ESG factors in credit ratings and the need for disclosure and armonisation by regulators. Even though as a reaction to ESMA statement some CRAs have then published their ESG related methodologies, their operational quest does not change its nature. Since a meaningful risk of conflict of interest due to the issuance of two opposite ratings (a full investment grade on credit and a non-investment grade on ESG for instance) on a single security, company or sovereign state could occur in that case, a CRA will not ever change its core business.
All things considered, there is consistent proof to claim that CRAs will not take over ESG ratings. ESG ratings remain a task of Sustainability Ratings Agencies, whose assessments are to be uniformed, shaped, monitored and controlled by Regulators, at least at the European level. Most importantly, their work is not under scrutiny and it is a symptom that Sustainable Finance is becoming Finance spin-doctor with a specific purpose: to invest on the doggedness of the Planet for the sake of future generations.
Sources:
[1] Huw Jones “EU watchdog says ESG rating firms need rules to stop 'greenwashing’”. Reuters.
[2] UNEP Finance Initiative – United Nations Global Compact. Shifting perceptions. ESG, Credit Risk and Ratings.
[3] Nadège Tillier “ESG and credit rating agencies: The pressure accelerates” - THINK Economic and Financial Analysis blog.
[4] BNP Paribas “Friends or foes: a world of credit ratings and esg scores”..
[5] Standard&Poors – Press Release “S&P Global Ratings Launches ESG Sections In Corporate Credit Rating Reports”.
[6] ESMA – Press Release “ESMA advises on credit rating sustainability issues and sets disclosure requirements”.