Investors and credit rating agencies (CRAs) are ramping up efforts to consider environmental, social and governance (ESG) factors in credit risk analysis.

Shifting perceptions: ESG, credit risk and ratings (Part 1: The state of play) is the first in a three-part series to enhance the systematic and transparent consideration of ESG issues in the assessment of the creditworthiness of borrowers in fixed income (FI) markets.

It provides a snapshot of the current state of play on ESG in credit risk analysis (in terms of thinking and activities) to better understand what investors and CRAs are already doing, what they are aiming for and what their expectations are. Parts two and three will provide more in-depth coverage on existing challenges as well as future opportunities.

There is tangible evidence of progress in ESG consideration by investors and CRAs, including increased resource allocation. However, they are at different stages in this process and look at credit risk from different perspectives:


Some efforts made by investors in ESG integration are incipient; some are partial, and some are more advanced.

Overall, ESG analysis is yet to be systematically integrated into credit risk assessment. It can be advisory in nature and the responsibility often falls on ESG analysts alone to raise “red flags”. Hence, at this stage, full ESG integration appears some way off. 

CRAs are integrating many ESG factors into their credit rating analysis, but must communicate this better.

While an assessment of governance has traditionally been included, CRAs acknowledge that they need to be more explicit and transparent about other ESG factors – namely social and environmental ones – too. 

Investors may not have realistic expectations of CRAs.

This is partly due to confusion around what ratings measure and expectations that ratings need to be calibrated to capture risks that they are not designed for (i.e. beyond default risk). 

CRAs are bolstering their research efforts.

CRAs are increasingly researching ESG topics beyond traditional rating analysis. This is contributing to the development of evaluation tools and deeper understanding of the issues at stake. However, it remains to be seen whether research insight is embedded in rating analysis going forward. 

 The report also sheds light on areas of best practice and bottlenecks, including:

Visibility of ESG factors

  • There are no perfect time horizons for assessing these, as they depend on the nature of the factors. Investors are asking for more guidance from CRAs, about the direction of risks; while this is provided to an extent by Credit Watches, Outlooks and Outlook statements, CRAs could take a more granular approach to ESG consideration and include scenario analysis to address long-term trends and risk trajectories. These are particularly important when it comes to assessing the possibility of upgrades or downgrades on which markets trade. There is also a lack of agreement on which time horizon to focus on, since ESG analysts tend to be more long-term oriented than portfolio managers (PMs), while CRAs vary.

Materiality of ESG risks

  • It is important to differentiate the ESG factors that may affect the financial performance of an issuer, its risk of default and the trading performance of its securities. These are not always straightforward to identify, however, due to data restrictions, confusion about which metrics to prioritise, and the nature of ESG risks (which may be new to both investors and CRAs). When considering the risk of default, some thought should also be given to how ESG factors may affect expected losses.

Environmental issues gaining traction

  • CRAs and investors most frequently cite governance as the ESG factor that is likely to directly impact creditworthiness. However, recent research by investors and CRAs suggest their focus is intensifying on environmental and green factors in particular, and less so on social factors which are less tangible.

Communication and transparency

  • Improvements are needed on both sides: CRAs generally agree that they need to enhance their external communication and transparency with investors. At the same time, investors have to improve internal dialogue (and cooperation) between ESG analysts and portfolio managers, who have the final investment call.

The findings of this report point to a number of themes that will shape the agenda of industry forums led by the PRI. The forums will enable market participants to address some of the questions which have emerged so far. For example:

  • How can investors and CRAs address the issue of timeframes for long-term ESG risks?
  • How can investors and CRAs use their improving ESG competence to enhance information disclosure by issuers?
  • Should investors give consideration to non-credit rating tools (i.e. an ESG score) that can help them assess risks beyond default risks?
  • Do regulators play a role in facilitating the systematic and transparent integration of ESG consideration in credit assessment?
  • How could institutions on both the investor and the CRA side – and their credit analysts – be incentivised to enhance their ESG competence and incorporate it systematically in their analysis?
  • As ESG factors are often intangible, how can qualitative assessment be improved for the purpose of credit risk analysis?

We welcome all feedback on this initiative; the challenge is to channel efforts constructively, efficiently and effectively to drive real change.

This report is only the beginning of more work that lies ahead. We acknowledge that these findings may not necessarily reflect industry views across the board, particularly on the investor side, and strongly encourage interested parties to work with us in taking this important project forward by getting involved in the activities being planned with the help of the ACCR.

The ESG in Credit Ratings Initiative receives financial support from The Rockefeller Foundation

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