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Credit Assessment Scorecards and ESG Factors

 

  • The Challenge
  • The Solution

Assessing ESG Factors in Credit Risk Analysis

Environmental, social and governance (ESG) risks have historically been perceived as taking place over the long term, so not materially impact an issuer’s cash flow and funding ability. There is increasing evidence, however, that ESG factors can affect credit risk[1] and investment performance[2] in the shorter term. ESG factors have often been intangible and building a more quantitative ESG framework can be a complex process for credit analysts. Accessibility and reliability of data and the modeling of relatively new risks are important to enhance the dependability of ESG factors in credit assessment. In addition, consistent disclosure of information by companies could assist analysts in performing credible peer analysis on ESG credit factors.


[1] Regular ESG Industry Report Cards published by S&P Global Ratings.
[2] “ESG funds outperform S&P 500 amid COVID-19, helped by tech stock boom”, S&P Global Market Intelligence, August 13, 2020.

Assessing ESG Factors in Credit Risk Analysis

S&P Global Market Intelligence’s Credit Assessment Scorecards provide a structured framework for assessing credit risk, generating credit scores that are designed to broadly align with credit ratings from S&P Global Ratings.[3]  Our Scorecards enable ESG factors to be considered in credit risk analysis in a transparent and structured way, while working through the regular credit assessment process.


[3]  S&P Global Ratings does not contribute to or participate in the creation of credit scores generated by S&P Global Market Intelligence. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence PD credit model scores from the credit ratings issued by S&P Global Ratings.

A Transparent and Systematic Framework

For each of the three ESG dimensions (environmental, social, and governance), we first define the ESG credit risk factors, which are the factors that influence the capacity and willingness of an obligor to meet its financial commitments and that can have negative or positive credit impacts.

We then provide guidance on how to integrate these factors in the credit assessment. This analytical process remains mostly evidence-based, qualitative and, accordingly, rules driven. ESG factors can be considered in several areas within the Corporate Scorecard framework, including management and governance, country and industry risk, competitive position, and cash flow/leverage. as shown in Figure 1.


  • Reflecting Governance Credit Risk Factors
  • Reflecting Environmental Credit Risk Factors
  • Reflecting Social Credit Risk Factors

Reflecting Governance Credit Risk Factors

Governance factors in the Corporate Scorecards are used for the assessment of management and governance, and include:

  • Ownership and board effectiveness
  • Management culture and internal controls
  • Transparency and reporting
  • Regulatory, tax, and legal framework and infractions
 

The Scorecards have long incorporated an explicit review of management and governance. All elements of governance are qualitative by nature and detailed guidelines and metrics are provided following a rules-based approach.

Reflecting Environmental Credit Risk Factors

Users can also incorporate environmental credit risk factors across all sectors in the appropriate sections of the Corporate Scorecards, when these factors are material and relevant to the credit assessment. The most common examples of environmental credit factors are:

  • Greenhouse gas (GHG) emissions
  • Pollution and waste
  • Biodiversity, water, and land use
  • Natural conditions

Reflecting Social Credit Risk Factors

Finally, users can incorporate social credit risk factors across all sectors, when these factors are material and relevant to the credit assessment. The four major social factors, divided into two groups include:

Internal social factors:

  • Safety management
  • Human capital management
 

External social factors:

  • Consumers and demographic trends
  • Social cohesion and community
 

The selection of the most appropriate section of a Scorecard to reflect material social factors will depend on whether the factors are expected to impact creditworthiness, based on a review of the visibility of the risks and the entity´s preparedness. It also depends on how reliable the estimation of their impact is on both the balance sheet and profit and loss statements.


Factor ESG in Credit Risk Analysis

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