Rating agencies are likely to play an integral role in helping push asset owners and fund managers to adopt environmental, social and governance (ESG) considerations in fixed income investing, believe experts in the field.
Most fixed income investors already rely on credit ratings to decide the broad riskiness of the public bonds; having them also measure ESG as part of that process makes sense. And the world’s largest agencies have been seeking to bolster their ESG analysis and credentials. That’s having an impact.
Ilya Serov, associate managing director with Moody’s in Sydney, told AsianInvestor that as investors have asked more about ESG, the agency has sought to strengthen the level of disclosure it offers over ESG issues.
He noted that Moody’s has assessed and ranked the exposure of all corporate sectors to environmental risk, from low to elevated levels, including areas such as carbon emissions, water shortages and vulnerability to natural disasters. This research has helped it better ascertain ESG factors in its ratings.
Serov noted one example was when the rating agency upgraded Japanese auto maker Nissan from A3 to A2 in January 2017. It did so in part because the company showed it could adapt to carbon emissions transition risks.
FITCH'S ESG CREATION
Fitch has been more assertive, creating a global ESG analysis team and conducting intensive conversations with global investors to understand their ESG preferences.
Andrew Steel, head of sustainable finance at Fitch Ratings said fund managers wanted four things: to identify ESG risks and their relevance, to show how these risks affected its rating decisions to individual credits, to identify systemic risk, and to name and shame issuers who weren’t disclosing enough.
The credit rating agency is doing all except the last, and by mid-2019 it intends to assign an ESG credit relevance score of one to five (irrelevant to directly relevant) to 14 sub-categories across E, S and G for each company it rates. Steel said an individually high ESG credit relevance score wouldn’t cause a rating downgrade, but three scores at four or worse could. The scores don’t judge ESG practices, but consider ESG elements affecting rating decisions.
The seriousness with which credit rating agencies pursue ESG scoring is important for engagement. “Issuers are realising that the rating agencies care more and more about ESG,” said a head of fixed income investment at a global fund manager. “The fact they care really makes investors care more about ESG in fixed income too. And repeat issuers have to care about the impact on their traditional ratings a lot more too.”
Plus, the research of the agencies is likely to be used by many fund managers and asset owners as a form of risk benchmark, much as their ratings already are. Fitch’s Steel believes they could become a proxy for ESG investing among smaller fund houses.
“Really big asset managers can afford their own departments and create their own systems; for them the sort of thing we do is useful for external reference and checking,” he said. “But for the vast majority of asset managers which aren’t sitting on a trillion dollars in assets there is a real need for this. They can’t afford a team of 10 analysts and are reliant on external sources that can rank credits across the board in the same way.”
SLOW AND STEADY
As more companies feel the need to report more ESG metrics in equities and are pushed to disclose such information by the likes of rating agencies, so credit investors will have more information to assess them too.
They certainly appear interested in the topic. “Over the next three years not everybody will engage, but I’d not be surprised if we saw the majority of investors in major jurisdictions doing so,” said the fixed income head. “There are always late adopters, or those that lack resources, but those that can are likely to do so.”
Doing so should at the very least help fixed income investors improve their due diligence and risk analysis. Companies that don’t take ESG seriously are exposing themselves to potential environmental and regulatory risks, after all.
Yet as institutional investors consider adding ESG factors into the fixed income assets, they need to consider their end objective for doing so.
“Every asset owner and fund manager has a difference in approach,” said Kevin Kwok, vice-president for ESG fixed income at index provider MSCI. “In the end they need to sit down and say ‘what is our mission or vision?’”