The Principles for Responsible Investment (PRI) has today launched a new report, Shifting perceptions: ESG, credit risk and ratings – part 2: exploring the disconnects, examining the gaps between investors and credit ratings agencies (CRAs) highlighted in its seminal work, Shifting perceptions: ESG, credit risk and ratings  part 1: the state of play, last year. 

This is another milestone of the ESG in Credit Ratings Initiative. The report presents the main findings of roundtables organised by the PRI which engaged credit practitioners from investors and CRAs on environmental, social and governance (ESG) topics for the first time in this format and at this scale.

The discussions addressed misconceptions such as the difference between assessing the impact of ESG factors on credit risk and evaluating a bond issuer’s ESG exposure. They also highlighted the progress CRAs are making – particularly the bigger players – through research and organisational changes, as well as on improving transparency. Roundtable attendees generally agreed that, although considering ESG factors in fixed income assets is primarily a tool to manage downside risks, it is also becoming more valuable to enhance returns or for relative value investment strategies. Commercial pressures from rising client demand are also mounting.

With support from The Rockefeller Foundation, the investor-CRA dialogue that the PRI is nurturing has revealed that some apparent disconnects are in fact shared challenges that credit practitioners on both sides are encountering as they try to make ESG consideration more prominent or rigorous. As well as observations from the forums, today’s report contains examples from CRA credit rating opinions or research and investor case studies demonstrating how ESG factors can affect the assessment of creditworthiness. Finally, the report is corroborated by the results of a survey that participants took before attending the roundtables.

“ESG factors are not new to credit risk analysis, but practitioners are starting to consider them explicitly, strategically and systematically,” said Carmen Nuzzo, PRI Senior Consultant, ESG in Credit Ratings Initiative. “The ongoing dialogue among peers is moving thinking forward, but more collective work is needed.”

Highlights from the report include:

■ while an assessment of governance factors is not new to credit risk analysis, both sides concur that assessing where environmental and social factors are relevant and how they can impact balance sheets and cash flow projections needs more work;

■ participants agreed that there is no silver bullet to identify the right time horizon over which to assess ESG factors in credit risk analysis. Due to the multi-dimensional nature of ESG factors, difficulties in modelling and capturing data interdependencies were cited among the biggest obstacles to ESG consideration;

■ expertise and resources are improving among both investors and CRAs, particularly where there is senior management buy-in. The level of CRA participation during the roundtables is a testament to this. However, building a formal framework to ensure that credit analysts systematically consider ESG factors is still a work in progress; and

■ communication and transparency on ESG topics has been limited until recently, partly due to a lack of outreach or engagement, which is now improving. Gaps exist at different levels of the investment chain – not only between investors and CRAs but between asset owners and asset managers and, ultimately, bond issuers.

“As investors and regulators increasingly focus on the role of the debt market in facilitating sustainable finance, the findings of this report highlight how important our initiative is in building knowledge and fostering action,” said My-Linh Ngo, Head of ESG Investment Risk at BlueBay Asset Management and chair of the PRI’s Advisory Committee on Credit Ratings. “These events – offering practitioners valuable time and space to reflect and debate – should be viewed as a stepping stone towards meaningful progress.”

Part three in the series, to be published at the end of this year, will examine possible solutions that started to emerge during the discussions.

To date, over 130 investors have signed the ESG in Credit Ratings Statement (representing more than US$26 trillion of assets under management), as well as 15 CRAs – including Moody’s Investors Service and S&P Global Ratings – as well as smaller, specialised regional players. The statement remains open to new investor and CRA signatories.

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    Shifting perceptions: ESG, credit risk and ratings – part 2: exploring the disconnects

    June 2018