Investors demand finer detail on ESG credit ratings
Launched to satisfy increasing investor interest, the new integrated scoring system will home in on how each ESG factor of an asset affects a credit rating decision
Institutional investors are now demanding more transparency and granular information on how environmental, social, and governance (ESG) factors impact the credit rating of specific bond issues as part of their risk analysis.
At present the closest thing most credit rating agencies (CRAs) offer are green bond scores which are not part of their credit rating processes.
"Essentially investors have asked for more transparency on how ESG is affecting the credit rating of each issuer. Until recently, all the three main CRAs argued that if something is material it's contained within the credit rating. But if you are ESG focused, you want to identify those specific risks," says Andrew Steel, managing director & global head of sustainable finance at Fitch Ratings.
The challenge is that the existing credit rating methodologies are too general and not entity specific to be able to draw ESG-related information which will be useful to ESG-focused investors, Steel says.
In response to this investor demand, Fitch Ratings has launched a new integrated scoring system that shows how ESG factors impact individual credit rating decisions made by its analysts.
Known as the "ESG Relevance Scores", the scoring system produced by Fitch Ratings' analytical teams transparently and consistently display both the relevance and materiality of ESG elements to the rating decision. They are sector-based and entity-specific.
For example, among 77 issuers in Asia-developed markets, governance ranks as the highest among the ESG elements driving the highest credit impact, followed by social and environmental.
Fitch is introducing ESG Relevance Scores across all asset classes, starting with over 1,500 non-financial corporate ratings. This will be followed the scores for banks in mid-February, scores for sovereigns in end February, scores for public finance in March, and structured finance afterwards.
Fitch's ESG approach fills a market gap by publicly disclosing how an ESG issue directly affects a company's current credit rating. Fitch is initially making all of its ESG Relevance Scores available in the public domain, and will then maintain and publish the scores on an ongoing basis as an integrated part of its entity credit research, Steel says.
Fitch views the introduction of ESG Relevance Scores as a substantial step forward in enhancing transparency for investors, and for the broader discussion around ESG and credit. Fitch's approach provides investors with the opportunity to examine, discuss and challenge opinions about how ESG factors have impacted rating decisions.
"We actively engaged with investors and other market participants to understand what they want to see from CRAs before devising the new relevance scores. Our focus is purely on fundamental credit analysis and so our ESG Relevance Scores are solely aimed at addressing ESG in that context," Steel says.
He adds, "The scores do not make value judgments on whether an entity engages in good or bad ESG practices, but draw out which E, S, and G risk elements are influencing the credit rating decision. We have taken a fully integrated approach to ESG, which will see the scores being done by our existing analytical teams rather than centrally."