What Keeps You Up at Night?
CFOs have a new answer to this common investor question…credit ESG ratings. As ESG plays an increasing role in the outlook for businesses, FTI sees traditional credit rating agencies like Fitch, Moody’s, and S&P starting to develop formal ESG ratings and scores, with the potential to impact corporate credit ratings and thus, credit terms and financing rates, from lenders. In this paper, FTI Consulting reviews this nascent product offering, along with potential impacts to corporate clients.
ESG ratings are nothing new. The conventional variety from MSCI, Sustainalytics, Refinitiv, ISS, and others have existed in some form or another during the past 30 years, requiring attention from corporates as they respond to a disparate set of contentious methodologies that seek to quantify their ESG programs and disclosures relative to peers. For the most part, this has meant that chief sustainability officers, external relations, and corporate communications professionals have been tasked with engaging these providers to increase disclosure and drive their company scores higher in pursuit of greater inclusion in various ESG-focused equity indices. In this sense, conventional ESG ratings have already had potential impacts on the equity side of the capital structure, to date.
However, there are a new set of ESG ratings on the scene…and these will likely gain elevated attention from CFOs and the broader finance organization in the months and years ahead. Traditional credit rating agencies (CRAs) like Fitch, Moody’s, and S&P have long claimed that ESG factors had the potential to influence their credit rating frameworks, but it hasn’t been until recently that these organizations have started rolling out a more formalized approach to measuring and disclosing corporate ESG risks and their impacts on overall credit ratings8. Enter…credit ESG ratings. These new products are not surprising, given the consolidation of the ESG rating market through several major purchases from traditional financial players. In recent years, Moody’s bought Vigeo Eiris while S&P bought the ESG ratings arm of RobecoSam, emblematic of efforts to build out a more formal ESG ratings business.
In 2019, Fitch launched ESG Relevance Scores (ESG.RS), which describe ESG risk impacts to Fitch credit ratings for corporate issuers. A year later, it launched ESG Vulnerability Scores (ESG.VS), which describe credit risk vulnerability of corporate issuers from the transition to a 2°C warmer climate by 20509. Fitch only covers a small number of sectors with its ESG.VS product today, however it has established wider breadth for its ESG.RS product thus far. In 2021, Moody’s launched Issuer Profile Scores (IPS) and Credit Impact Scores (CIS), with the IPS detailing which ESG factors affect Moody’s credit ratings and the CIS indicating how strongly these ESG factors affect Moody’s credit ratings. Moody’s has been expanding its coverage into new sectors during 2022, and this work is expected to continue during 202310. Finally, S&P started publishing ESG Credit Indicator Report Cards for select sectors in late 2021/early 2022, with plans to add ESG Credit Factors to S&P credit rating publications in the future (when such factors drive a credit rating action11).
These new credit ESG ratings have the potential to influence traditional credit ratings, which is meaningful for all companies, both public and private. Banks and other financial intermediaries have long used credit ratings as partial inputs to their lending decisions, credit applications and terms. With increasing transparency around ESG issues and the evolution of sustainable finance products (Green, Social, and Sustainability bonds, Sustainability-Linked Loans, etc.), third-party reviews of borrower sustainability are increasingly valuable as they allow for a more thorough evaluation of credit market risk. Thus, FTI believes that a direct line can be drawn between credit ESG ratings from Fitch, Moody’s, or S&P to potential financing terms from banks and other lenders. Of note, we are already witnessing this occurrence in both the bank loan and private debt markets, based on interactions with industry contacts.
As CRAs more forcefully enter the ESG market, opportunities for both positive and negative implications of ESG performance are amplified. All companies that are rated by CRAs must now begin to proactively address their ESG performance, and the perception of their ESG performance by CRAs, as the potential impact to their cost of debt is real. Investment in a formal ratings improvement program can therefore now drive potentially meaningful direct savings in cost of capital.
Source: https://www.bis.org/publ/work747.pdf
For companies pursuing sustainable finance products, understanding credit ESG ratings is also important. Borrowers must understand how CRAs and lenders will evaluate their sustainability to ensure they maximize benefits, and thus minimize cost of capital, associated with these tailored products.
FTI Consulting experts have considerable experience helping clients navigate conventional ESG ratings, built on our proprietary rating improvement models and our intimate knowledge of individual scoring methodologies. We expect there to be controversy around credit ESG ratings, much like their conventional counterparts. Fully transparent methodologies on ESG scoring are not yet available from Fitch, Moody’s, or S&P, leading to challenges around peer comparison and meaningful corporate response. The experts at FTI Consulting have mapped key issues between conventional ESG ratings providers and credit ESG ratings providers, such that we can leverage additional transparency in the conventional ESG market to help corporate clients respond to credit ESG rating reports with actionable disclosure practices today. We are prepared to help firms interpret the nuances of their credit ESG ratings reports and develop disclosure and engagement strategies in response to CRAs, banks, and investors. Our roadmap also allows FTI Consulting to leverage our expertise in ESG goal, KPI, and target setting as corporate clients engage in conversations with banks that are responding to new ESG-influenced credit rating reports.
As is the case today, a sound corporate ESG approach, program, and strategy to communicate achievements and plans to key stakeholders, including rating agencies, offers the best proactive defense against evolving regulation and risks to the business, its capital structure, and its people.
The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, Inc., its management, its subsidiaries, its affiliates, or its other professionals.
FTI Consulting, Inc., including its subsidiaries and affiliates, is a consulting firm and is not a certified public accounting firm or a law firm.
1) https://www.fitchratings.com/
3) https://www.spglobal.com/ratings/en/
5) https://www.sustainalytics.com/
6) https://www.refinitiv.com/en
7) https://www.issgovernance.com/
8) https://www.jdsupra.com/legalnews/sec-elevates-esg-priority-in-credit-3627330/
9) https://www.fitchratings.com/topics/esg
10) https://www.moodys.com/newsandevents/topics/ESG-Credit-00702C
11) https://www.spglobal.com/ratings/en/research-insights/special-reports/esg-in-credit-ratings
| The views expressed in this article are those of the author(s) and not necessarily the views of FTI Consulting, its management, its subsidiaries, its affiliates, or its other professionals.
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