ESG in credit risk: Workshop with borrowers in the chemical sector

As is common in PRI workshops, participants frequently cited the availability, quality, and range of data as an issue. Investors and CRAs saw a need for more standardised data, improved responsiveness by borrowers and an increased number of data points on governance. Some investors expressed a preference for absolute rather than relative data, as companies may not use the same ratios, for example to assess emissions reduction targets.

“We would like to see raw data…We want to have visibility over the perimeter of the geography and activities included when it comes to data.” – Investor

Investors would find it useful to have more granularity on energy targets, on the energy mix in a company’s energy portfolio and on investments towards these targets. Focusing on plastics, investors are seeking to understand the percentage of plastics that can be recycled, what technologies are used in recycling and whether capex is consistent with targets.

“The EU regulatory push will start to encompass the circular economy. But on the metrics, the tech and the data, there is a long way to go.” – Corporate borrower

Investors, corporates and CRAs acknowledged it is challenging to define which metrics they should look at, measure and report on. For instance, which environmental and social factors can affect cash flow and liability profiles, and how does that change over short, medium and long-term horizons?

“What is good? How good is good enough? And then, based on that, do we only invest in the best performers and leave out the others? Investors do not know what they are measuring.” – Investor

There was consensus on qualitative data being as important as quantitative measures in assessing performance, for example when explaining the measures a company is taking to achieve targets and what lies ahead (including how many people are responsible for ESG, where they sit within the organisation, and who is in charge at management level). In addition, more reporting on employee skill levels and training would be welcome, given the importance of safety in the chemical industry and the need to attract and retain qualified staff.

Many borrowers noted they are reporting according to the Sustainable Accounting Standards Board (SASB), and some admitted that pressure to do so has increased following demands by large, influential asset managers. However, the Global Reporting Initiative (GRI), the Task Force on Climate-related Financial Disclosures (TCFD), Ecovadis and the UN Global Compact are also used, creating a desire for convergence.

“We would like to have one consistent set of data. Similarly to accounting standards converging towards IFRS, we hope to see the same harmonisation for the various ESG-related reporting standards.” – CRA

Investors look at many factors to gauge management’s commitment to ESG risks. They value face-to-face meetings, which often are helpful in judging the sincerity of CEOs and CFOs. Investors and CRAs seek to answer questions such as:

• Is there an ESG specialist?
• How frequent are investor engagements?
• What is the responsiveness to engagement?
• Is ESG a consistent topic in board discussions?

In addition, if responsibilities are clearly delineated, investors can examine board members’ profiles or résumés to complement information about ESG competence and commitment.

“By attending roadshows and in-person meetings, we often see whether the mandatory ESG slide is there just for show, or is it really meaningful? It helps us gauge the importance of ESG for the board, how the board makes the strategic decisions.” – Investor

Investors also value transparency about performance against goals, as well as clarity around any shortcomings. A company not explaining reasons behind missing ESG targets could signal lack of transparency.

In response, one borrower noted that this year compensation includes a factor that will be weighed against not only financial performance but also sustainability performance annually. Another shared that the chief environmental officer’s compensation is integrated with ESG factors.

Borrowers added that they welcome opportunities for engagement as so often creditors focus only on downside risk, e.g. litigation or potential controversies. They do not believe creditors can obtain a full picture of the company’s ESG efforts and opportunities with such a narrow focus.

CRA and investor participants see performance on environmental issues as critical to the future of the chemical sector. Companies that cannot make the transition to a sustainable economy within the next two decades may not survive. The carbon intensity of nitrogen fertiliser, for instance, would make it a difficult business to invest in without major changes.

Investors are already seeing increasing red flags for holdings in the sector. A client asked one asset manager to add pesticides to the exclusion policy, including companies deriving more than 5% of revenue from the production of synthetic pesticides. This kind of demand could become the norm in a few years.

“If companies are not on the front foot, showing why they are improving and how they will get there on their own, they may be surprised by what happens. It can happen by accident, e.g. with companies that are on the right path but with legacy assets.” – Investor

But at the same time, the chemical sector provides solutions for the energy transition and its products must be assessed through their contribution to extending life cycles. Borrowers saw both risk and opportunity. Addressing climate/energy efficiency adequately was seen as a risk while waste management, circularity and innovation presented opportunities. One borrower noted that exporting products to Europe means compliance with EU regulations on carbon emissions. On recycling, the opportunity is in strengthening the connection between waste collection and end products.

Finally, it was noted that biodiversity is an important issue for certain companies and that more information is needed for investors to be able to assess risks in this area. Chemical companies are large consumers of water, presenting drought-related risks. In addition, chemical companies are still occasionally polluting rivers.

The true challenge for investors is valuing and pricing transition planning. Companies are increasingly required to commit to long-term transitions but are measured against pricing models that do not factor in long-term challenges.

The discussions highlighted several considerations specific, but not unique, to the industries of the companies represented. The following are examples of areas where investors may request more information for ESG analysis, and where borrowers may seek to improve disclosure.