What’s behind S&P’s new ESG section in corporate credit ratings?

The ratings giant will now turn its focus to sovereign and bank bonds, Michael Wilkins tells RI

This month, to coincide with the PRI’s final report on sustainability in credit ratings, S&P Global Ratings announced plans to add an ‘ESG’ section to 2,000 of its credit reports.
On the face of it, it was a big move. Credit Ratings Agencies (CRAs) have been accused of exacerbating the fixation on short-termism by not addressing longer-term risk exposure. The focus on credit worthiness over a three- to five-year period means most ratings don’t capture climate change factors, for example, and some argue they therefore discourage issuers from addressing such risks.
Demands from investors and policymakers for CRAs to do more on ESG are often met with frustration, as CRAs point out that their hands are tied: their mandate is solely to highlight default risk over a bond’s average holding period, not to try and tackle systemic sustainability topics.
The response has instead been a trend for CRAs to address sustainability through additional services, including ESG assessments and green bond reviews.
But, for the first time, S&P will now add an ‘ESG’ section into the credit reports of all its ‘top-tier’ issuers – the largest listed companies, with the highest levels of outstanding debt. In addition, it will do the same for firms in the ‘second tier’ that it considers to be significantly exposed to financial material ESG factors. By the end of the year, around 2,000 issuers will be covered under the new process, representing some 40% of S&P’s corporate universe.
“Ultimately, this is about ESG and its impact on credit worthiness,” explains Michael Wilkins, Head of Sustainable Finance at S&P Global Ratings. “We’re looking at ESG exposure that might affect cash flow, profitability or debt levels, etc; how severe that exposure is; and the likelihood of a problem occurring from it. Wherever possible, we’ll indicate how the company compares with peers, for comparative purposes.
“If an ESG issue doesn’t affect credit quality, and doesn’t look likely to, then we won’t give our view on it.”
Last year, S&P Global Ratings found that it had 372 examples of ESG issues impacting credit ratings between 2015 and 2018, across all its issuers.Even if a company has no notable material exposure to ESG, it will still be noted in the new section of the credit rating, although, Wilkins says, “we imagine those cases will be pretty rare”.

“This move has gone down particularly well with the investment community” – Michael Wilkins, S&P Global Ratings

Carmen Nuzzo, who heads up the Credit Ratings Initiative at the PRI, said the UN-backed body “welcome[d] S&P Global Ratings’ proactivity and efforts to enhance transparency across its ratings analyses”.
In reality, though, the new approach is not that new and – as Nuzzo’s comments highlight – are centred on enhanced transparency, not enhanced ESG.
“It’s more about communication,” agrees Wilkins. “We’ve been analysing these issues for a long time, and we’re not asking for anything in addition to what issuers are already disclosing. But we wanted to make it clearer that we do look at ESG, and make it easier for those who use our opinions to see how and where we do that.”
He acknowledges that S&P has been “mindful” of the European Commission’s efforts to get the European Securities and Markets Authority (ESMA) – the body that regulates CRAs – to step up on sustainability. But, he insists, the main driver for the changes is the investor community.
“They’re asking for this to be more prominent and communicated in a better way, so this move has gone down particularly well with the investment community.”
The focus is currently on corporate bonds, but Wilkins says process is already underway for issuers in financial services, public finance and sovereign practices too, and they will follow “shortly behind corporates”.

Responsible Investor is hosting roundtable workshops for asset owners and their consultants on ESG integration into fixed income: assessing credit risk and engaging for value.
Click here to register for a city near you. RI Workshops are now CPD Certified.