February 4, 2020 - According to a 2018 UNPRI report, 86% of asset owners are considering ESG/active ownership when selecting asset managers – a 31% increase from 2017 – and 78% when monitoring their asset managers – a 25% increase YoY. To that end, over 80% of investors now have sustainable, impact or ESG policies. The undeniable push for ESG integration into investment frameworks has caused investors to call on credit rating agencies to systematically incorporate ESG characteristics into their issuer ratings. Recognizing this trend, the LSTA has hosted a three-part series dedicated to ESG and credit ratings. As the final installment of this series, Fitch Ratings presented the recent webcast “ESG Integration into Credit Ratings” where Andrew Steel, Global Head of Sustainable Finance, explained in detail Fitch’s integral and credit focused approach to displaying sector and issuer level ESG credit risks across its credit ratings through its ESG Relevance Scores and Heat Maps.

It is important to remember that ESG has historically been a part of traditional credit analysis, but what is happening now is that the ESG components of that analysis are being made transparent. Fitch’s ESG Relevance Score is not measuring ESG risk itself rather it is measuring which ESG risks appear in any given credit rating – the intersection between ESG risks and credit risk. The Scores (based on a scale of 1 to 5) identify the specific ESG risks that are potentially relevant for each issuer’s credit profile and of those which ESG risks are relevant for the entities in that sector (and even country or region). Next, the Scores look at which ESG risks have risen to a level where they are an active factor in the rating decision, on an issuer-by-issuer basis, and which ESG risks actually led to a rating change. This is a forward-looking analysis on a two to three year rolling basis.

So how often does an issuer rating have a score of a 4 or 5 (meaning at least one score that is a key rating driver or a driver of the rating)?  On a sector basis, 22% of corporates saw some impact, 20% of financial institutions, 100% of sovereigns (because governance drives the rating), 5% of public finance and infrastructure, and 18% of structured finance. From a credit perspective, we see that it is important and does have an impact across analytical groups.

Drilling down into one of these groups, such as corporates, we see that, as one might expect, governance has been found to be the most influential factor in credit ratings. What might be more surprising, however, is that Fitch has found social factors to be much more influential than environmental factors. Overall, corporate issuers in developed markets experience the greatest credit impact from governance elements, followed closely by social elements and substantially less so by environmental elements. By region, however, there is variation. In Asia, you see much less impact from environmental elements but about the same from social and governance elements. The Americas follows the global trend, and in Europe, social elements have the greatest impact (by a slight margin compared to the impact of governance elements) and environmental elements having somewhat less impact. In emerging markets, governance elements are the most influential, with environmental lagging that and social elements having the least impact.

For more information, please refer to the presentation, webcast replay, and supporting material available here. Andrew Steel also kindly prepared responses to the questions posed during the webcast. That Q&A is available here (at the bottom of the page). For the rest of this series, please refer to the S&P Global Ratings webcast and Moody’s Investors Service webcast.