Credit rating agencies are having a busy summer. First it was Moody’s taking a swing at US banks, and now, Standard & Poor’s has announced that it will stop grading the influence that environmental, social and governance factors may have on a company’s credit score. Is this evidence that anti-woke investing sentiment in the US may finally be having an impact at these firms?
Firstly, it is important to clarify that a lot of the media noise that has followed S&P Global’s decision comes from a misunderstanding over what exactly is changing and why. The rating agency’s own messaging has not helped.
The semantics
S&P Global is not actually dropping ESG scores. Rather, it is removing the numerical ESG credit indicators that were part of their credit rating reports.
The US agency started publishing ESG scores in 2020. They are measured on a scale of zero to 100 and consider “the most relevant criteria in each sustainability dimension based on their weight in the assessment and their current or expected significance for the industry”, according to the firm.
For example, S&P Global’s own ESG score is 89/100 as of December 16, 2022, and is based on "very high" data availability on criteria such as human capital development, business ethics and climate strategy.
In 2021, the firm announced in its roadmap that it was planning a number of initiatives to improve how it assesses ESG factors across all sectors globally, including how ESG factors influence creditworthiness.
S&P Global Ratings subsequently began publishing ESG credit indicators for publicly rated entities in some sectors to summarize the relevance of ESG credit factors on its rating analysis from a scale of one to five.
When a company scores a three in 'environmental credit indicator', that means that environmental factors have a “moderately negative” influence on S&P’s credit rating analysis of that company.
The roadmap specifies that neither the S&P Global ESG score nor the ESG evaluation are inputs to its credit-ratings analysis. But earlier this month, the agency scrapped that scale and decided to stick to the qualitative assessment in the credit-ratings reports, which describes the impact of ESG credit factors on creditworthiness.
But while the documentation explains the methodological differences between the scores and the credit indicators, S&P Global has said very little about why it made the decision to get rid of the latter.
Rumour has it
It is, therefore, hardly surprising that the market has been speculating that this could be evidence that the push by rightwing anti-ESG politicians and commentators to reduce the influence of ESG factors on the investable universe is now hitting credit rating agencies. Recent legislative attacks coming from Republican states in the US provide compelling supporting evidence.
In September 2022, Missouri’s attorney general Andrew Bailey launched an investigation into S&P Global, claiming that the agency may have been violating consumer protection laws by letting ESG factors influence credit worthiness.
Has the ESG acronym now become so politicized that it is impossible for a credit rating agency to change its mind on one aspect of its methodology without some sort of political blowback?
Borrowers have been subjected to similar political pressure in the US and may therefore be motivated to ask ratings agencies to loosen the grip that ESG assessments have on credit evaluations – or at least make it look like extra-financial factors have less influence on credit scores than a one-to-five scale suggests.
S&P Global has, however, described this as an independent and analytical decision.
“After further review, we have determined that the dedicated analytical narrative paragraphs in our credit rating reports are most effective at providing detail and transparency on ESG credit factors material to our rating analysis, and these will remain integral to our reports,” it says.
But earlier this week, Bailey published a statement applauding S&P’s decision “indicating they are changing course and following the law by putting its shareholders before a political agenda”.
This may be simply a selective and partisan interpretation, but the message sticks.
Staying relevant
Has the ESG acronym now become so politicized that it is impossible for a credit rating agency to change its mind on one aspect of its methodology without some sort of political blowback?
It is clear that in such a rapidly evolving regulatory environment, credit agencies must adapt their approaches to ESG. There is intense scrutiny of sustainability considerations in the US, which has been echoed by institutional efforts to tighten policies around ESG ratings providers in Europe.
The European Commission put forward a legislative proposal in June that would give more power to the European Securities and Markets Authority (ESMA) to scrutinise agencies that provide ESG and other credit ratings.
As the sustainability disclosure process matures and quality ESG data becomes more freely available to the market, these firms will be under growing pressure to demonstrate that ESG evaluations, scores and credit indicators have value. Maybe that starts with re-evaluating how ESG credit ratings are calculated in the first place.
All credit ratings have an influence on corporate borrowing costs, and S&P’s rating methodology still includes ESG factors. That isn’t going to change just because the scale has gone.
And if the broader objective is to lower the cost of capital so that companies can borrow enough to make their transition happen, it makes sense to add flexibility to the way that ESG is factored into credit worthiness.
Maybe pleasing the anti-woke politicians for a while as part of this process is a small price to pay.
