Carmen Nuzzo, head of fixed income at the Principles for Responsible Investing (PRI), has said credit ratings agencies have significantly improved transparency around how environmental, social and governance (ESG) impacts a company’s credit score, however, more work is needed.
In particular, Nuzzo said there needed to be more upgrades and downgrades from credit rating agencies if a company’s ESG score materially changes, something which is currently not happening.
PRI’s fixed income head added ESG factors should be taken more systematically into account when a company’s credit rating is being assessed.
Earlier this year, an academic study conducted by the University of Pennsylvania’s Witold Henisz and James McGlinch found a correlation between poor ESG scores and increased credit risk.
The study argued “that, given the longer-term horizon of creditors and their focus on downside risk, investors when pricing fixed income securities should, like investors in equities, take account of the risk migration benefit from higher ESG performance”.
The PRI launched The ESG in Credit Risk and Ratings Initiative in 2016 with a view to seeing credit rating agencies take into account ESG factors when rating a company’s credit.
The initiative also looked to facilitate a dialogue between credit rating agencies and investors to discuss ESG risks to a company’s creditworthiness.
“We have seen big improvements in building the framework but now we need to see how ESG factors impact credit ratings. More upgrades or downgrades when ESG factors have a material impact on a company’s credit will start affecting their cost of capital and that is when we will see change.”
“We have seen big improvements in building the framework but now we need to see how ESG factors impact credit ratings,” Nuzzo commented.
“However, more upgrades or downgrades are needed when ESG factors have a material impact on a company’s credit.”
Before the initiative, Nuzzo explained many fixed income investors thought they could not have much of an impact in terms of company engagement but now they are looking at ways of doing this.
"Traditionally this was more in the equity space with shareholder meetings however, ad hoc engagement channels are open for fixed income investors to have an impact as well."