ESG factors have a direct impact on individual credit rating decisions
Governance risks are most relevant ESG risks to credit ratings; majority of environmental credit risks are greenhouse gas emissions-related, according to a new Fitch report
Governance risks are the most relevant ESG risks for credit ratings while individual ESG risks have some material impact on credit ratings, according to a new report from Fitch.
Earlier this year, Fitch launched the ESG Relevance Scores for Corporates, a new integrated scoring system that indicates how ESG factors impact non-financial corporate credit rating decisions. Using the Relevance Scores, Fitch conducted research and identified patterns for ESG elements within the credit market, which it describes in its “Connecting ESG Risks with Credit” report. The research focuses on cross-sector and regional trends for non-financial corporates.
The majority of environmental credit risks are greenhouse gas (GHG) emissions-related. Utilities and the auto sectors are most affected by tightening emissions regulations. Operational risks such as oil spills and disruption from extreme weather are less frequently credit-impactful than emissions issues.
Environmental risks such as water management issues are more region-specific and identified as relevant for the water utilities in the EMEA (Europe, Middle East and Africa)-regulated networks sector and for issuers operating in the UK due to a regulatory pricing regime that rewards or penalizes performance related to water management.
Social risks are relevant to more non-financial corporate issuers than environmental risks. Consumer behavior shifts in health considerations and regulations affect industries such as the food, beverage and tobacco sectors. Consumer trends mainly affect credit in developed markets (DMs). Social and political pressure on pricing is a common feature in emerging markets (EMs).
Governance risks are generally similar across sectors but there are significant differences across regions, reflecting local norms and structures. Issuers with complex governance structures are more common in DMs while lack of transparency and board independence are more common in EMs.
Governance structure is the most common element to drive the credit rating change. There is a strong linkage with potential financial impacts and governance structure issues such as alleged corruption, bribery and other violations.
Events that have clear financial linkage and cause large potential financial liabilities (such as mis-selling claims on payment protection insurance) or lengthy operational delays (such as tailing dam collapses) are highly relevant to credit ratings.
Fitch commented that further research is needed on whether the governance issue only became relevant following ESG event risks or could be a useful indicator for understanding the likelihood of experiencing such events.
Fitch will maintain the database of scores over time with the intention of helping future research on the linkage between ESG factors and fundamental credit factors across sectors.
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