Dirty downgrades: how ESG can affect credit ratings

Fitch Ratings will use a new system to study ESG factors when compiling credit ratings. Moody’s warns that debt worth $2.2 trillion across 11 sectors could be downgraded due to environmental risk.

Fitch Ratings is slowly turning up the thermostat to ensure the financial world feels the heat of rising environmental risk - and its implications on credit rating.

While Environmental, Social and Governance (ESG) factors have long been a consideration for corporates, the agency said it is set to become even more important. It will now judge corporates more closely by launching a new indicator that will be used to analyse 1500 non-financial corporates.

Similarly, Moody’s Ratings appears equally focused on highlighting ESG risk. Last year, it had warned that a significant proportion of existing debt in 11 sectors is at risk of being downgraded due to such concerns.

Results from FinanceAsia's recent investor survey show nearly 38% of investors will increase their ESG investments in 2019. 

While the overall picture in any rating consideration is complex, some sectors are more exposed than others.


On Monday, Fitch Ratings said it would now outline ESG Relevance scores across all asset classes sometime in the coming quarter.

“The scores do not make value judgements on whether an entity engages in good or bad ESG practices, but draw out which E, S, and G risk elements are influencing the credit rating decision,” said Andrew Steel, global head of sustainable finance at Fitch Ratings.

“Initial results show that 22% of our current corporate ratings are being influenced by E, S or G factors, with just under 3% currently having a single E, S or G sub-factor that by itself led to a change in the rating.”

They may be small numbers for now. Treasurers, however, should be mindful that the environmental impact of their physical supply chain could begin to affect the financial supply chain too.


A Singapore-based agribusiness producer known for its role in palm production serves as a pertinent example. Last year, Wilmar International inked two sustainability-linked loans with DBS and OCBC.

That did not stop the multinational company from being slammed by Greenpeace International in a report where the non-governmental organization said that “not only does Wilmar trade palm oil from more destructive producers than most of its competitors, but it is often their primary route to market.”

In response, Wilmar said that Greenpeace’s analysis was far from comprehensive.

“Greenpeace has singled out Wilmar in their report due to our size and scale of our operation but have neglected the fact that deforestation is being driven by the availability of a leakage market made up of suppliers without NDPE [no deforestation, no peat, no exploitation] commitments,” it said.  

The cumulative total for the two sustainability-linked loan facilities amount to just $300 million but they do represent a positive start. With an incentive structure inked into the agreement - Wilmar would enjoy lower interest rates on the loan if it met ESG targets – the palm trader is now one of many Asia-based corporates taking on more sustainable-linked financing in recent months. 

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As the example shows, large corporates are being scrutinized by multiple parties through an ESG lens. Regulations are ramping up on carbon consumption, air pollution, water shortages, soil and water pollution, and land use among many others.

While it’s hard to know exactly how relevant ESG concerns are for any given corporate, certain broad trends can be spotted.

Last September, Moody’s Investors Service released a report analysing the environmental exposure in debt markets. It found that $2.2 trillion in rated debt have elevated credit exposure to such risks.

“Coal mining and terminals, and unregulated utilities and power companies have already experienced material credit pressure as a result of environmental risks,” said the team of Moody’s analysts.

“For the remaining nine sectors – automotive manufacturers, building materials, commodity chemicals, mining, oil and gas exploration and production, oil and gas refining and marketing, steel, and the new additions of shipping, and transportation and logistics – exposure to environmental risks could be material to credit quality within three to five years.”

In total, Moody’s says that 84 industry sectors representing $74.6 trillion in rated debt will suffer from environmental risk from some sort. The figure represents a 10% increase from the number found in the previous study in 2015.                               
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It’s unclear exactly how such rating agencies will rate corporates when considering the confusing mosaic of ESG factors – some are hard to measure while others are interlinked.

In a separate Moody’s report analyzing green bonds – debt taken on usually by local governments for environmentally friendly projects – the agency conceded that any attempts to analyse ESG financing would always face problems.

Such green bonds are evaluated by how they contribute to the United Nations Sustainable Development Goals (SDGs) – a set of 17 goals agreed by member states in 2015. However, any social impact data usually tends to be qualitative and project specific, the report said, while many SDGs have overlapping objectives muddling the picture.  

“Another key challenge facing the adoption of the SDGs is the likelihood of difficult trade-offs among these individual goals. For example, SDG 2, related to food security, is threatened when crops are switched for biofuels in developing countries,” the report said.

“There is no consensus about how certain goals and objectives should be prioritized over others. As such, the adoption of the SDGs by investors and issuers raises an important question as to how market actors prioritize competing and, potentially in some cases, conflicting goals.”

Other benchmarks for green bonds such as the Climate Bonds Initiative's "Climate Bonds Standard" help investors to quantify their investments, but with other benchmarks possibly clouding the picture a new qualitative benchmark must surely be welcomed. 

Still, Fitch Ratings’ ESG Relevance scores should help make the picture clearer. The rating agency says that a preliminary analysis unearthed over 22,000 individual E, S and G scores for publicly rated entities.

ESG considerations are now firmly in the investor's arsenal, and its rising importance is something both investors and issuers are coming to coming to terms with.


Additional reporting by Andrew Wright

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