SUSTAINABILITY considerations are increasingly being incorporated into policies, corporate governance frameworks, and the lending and investment decisions of financial institutions.
This will increase the influence of ESG (environment, social and corporate governance) on company strategy, financing and operating environments in 2021, according to Fitch Ratings.
In its latest report on ESG Credit Trends 2021, the credit rating agency said it has identified five key ESG trends that are relevant to credit ratings:
Data deluge to increase ESG scrutiny: The quality and quantity of ESG data will be improved by increasing reporting requirements and harmonisation of standards. This will spur financial institutions to enhance ESG due diligence and exclusionary policies to cover a broader set of ESG issues and entities, further affecting financing conditions for issuers.
Innovation will broaden ESG reach in credit: The sustainable market is expected to evolve to incorporate labels beyond “green” (such as “social” and “transition”). Innovations such as sustainability-linked bonds (SLBs) will widen access to a broader range of sectors and asset classes.
Path to net-zero brings economic shifts: There were many net-zero emissions pledges from companies and governments in 2020 but how these will be achieved is unclear. The policy paths will provide insight into long-term economic effects.
Social risks will emerge from “new normal”: Social effects of the coronavirus pandemic such as greater inequality and poverty are poised to lead to societal tensions. The policies designed to alleviate them may lead to new social risks for issuers, and could exacerbate existing risks.
Sustainable governance to steer strategy: The growing interest in sustainability is sparking debate on how corporate governance frameworks should foster long-term responsible corporate behaviour. Combined with more active investor ownership and the formalising of sustainability targets into remuneration and sustainability-linked instruments, ESG issues will gain increasing influence in strategic and management decisions.
In a related development, Moody’s Investors Service yesterday published environmental, social and governance (ESG) scores for all its rated sovereigns following an update of its cross-sector ESG rating methodology, environmental risk is most often moderately negative or neutral at best.
Pertaining to environmental risk, Moody’s said around 40% of emerging markets (EMs) have “Highly Negative” or “Very Highly Negative” exposure, mainly due to physical climate or water risk and, for a few, carbon transition.
“This exposure is reflected in relatively low credit ratings when it coincides with weak governance and limited financial resilience,” noted Moody’s. “For a few hydrocarbon-reliant sovereigns, measures to mitigate exposure to carbon transition provide support for high ratings.”
On the social front, EMs are subject to “Moderately Negative” – or often “Highly Negative” – risks related to labour and income, education, housing, health and safety, and basic services.
“(Nevertheless) a significant portion of sovereigns have strong governance, directly contributing a positive rating impact from ESG and bolstering resilience to environmental or social risk,” reckoned Moody’s.
“But we assess the governance of some governments to be very weak, often reflecting both quality of institutions and policy effectiveness.” – Jan 19, 2021
