One of the three global ratings agencies adds ESG to its criteria for rating creditworthiness.
ESG factors, which include environmental, social and governance considerations, have been integrated in recent years into institutional investors’ review of companies and investment opportunities. Yet, ESG’s role in credit rating has been limited.
That’s changing. Most recently, Fitch Rating announced the launch of a program that includes ESG factors in its credit-rating process. The ESG scoring system will cover all asset classes and over 1,500 nonfinancial corporations. Future scoring may cover an even wider scope of entities.
According to Fitch, the new integrated scoring system will show how various sustainable factors impact individual credit-rating scores. The results so far show that negative effects on credit are still limited, with “just under 3% [of companies] currently having a single E, S or G subfactor that by itself led to a change in the rating,” says Fitch.
One concern of industry watchers in recent years has been the lack of clarity and standardization of ESG factors in financial ratings. To that end, the International Integrated Reporting Council (IIRC) and the US-based Sustainability Accounting Standards Board (SASB) have developed industry sector–specific reporting and relevance metrics.
Fitch’s scoring system focuses only on the actual impact of environmental, social and governance risks on financial and credit performance, and does it in a transparent and standardized manner. It remains to be seen how Fitch’s new approach will affect other rating agencies and the way investors assess corporate credit. However, as ESG factors become part of corporate disclosures more generally, this new integrated scoring system can bring more useful information to credit markets.
Several quantitative funds specializing in ESG have already started using various scoring systems to introduce new investment strategies. Arabesque, for example, is a new global fund that “integrates ESG information with financial and momentum analysis, processing over 100 billion data points.”