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Essential Intelligence: General Purpose

ESG in Credit Ratings

How ESG Factors Can Affect Credit Ratings

Credit ratings help foster the development and smooth functioning of capital markets. They are forward-looking independent analytical opinions on the capacity and willingness of an entity – such as a corporation or municipal government –to meet its financial obligations (to pay back debt and pay interest) in full and on time.

Environmental, Social and Governance (ESG) factors can – and do – influence credit quality, specifically, the capacity and willingness of borrowers to meet financial commitments. They have always played a prominent role in creditworthiness and, thus, in our credit ratings – even before the term ESG was coined more than a decade ago.

What do ESG credit factors in our credit ratings look like?
ESG credit factors are those ESG factors that can materially influence the creditworthiness of a rated entity or issue and for which we have sufficient visibility and certainty to include in our credit rating analysis. We incorporate ESG credit factors through the application of our sector-specific criteria when we think the ESG credit factors are, or may be, relevant and material to our credit ratings. Also, ESG credit factors can be positive, neutral or negative to creditworthiness, depending on the entity being rated.

Whenever S&P Global Ratings takes a rating action – an upgrade, a downgrade, a CreditWatch, or an outlook change – we announce the change and the full analytical rationale to all market participants at the same time. The written opinion for the rating change will include the various factors we believe are affecting our forward-looking view of creditworthiness. When an ESG credit factor is driving credit quality, it’s outlined explicitly and transparently in our publicly available rating actions.

We believe that for credit ratings to be meaningful to market participants that they should embrace and reflect ESG credit factors alongside other credit considerations, where material and relevant to creditworthiness. As the need for understanding the impact of ESG on debt issuers everywhere continues to grow, S&P Global Ratings is listening and responding by enhancing its focus on ESG, with greater visibility in our criteria and transparency in our publications.

Additional Information:

Request For Comment: ESG Principles In Credit Ratings

ESG Pulse

Why Credit Ratings May Change During Times Of Market Volatility

Credit Rating Definitions

At times, an entire sector will have its prospects impacted by ESG considerations. Recently, we’ve updated our industry risk assessment for the oil and gas integrated, exploration and production industry to incorporate several increasingly material risks, including the energy transition.

This oil and gas integrated, exploration and production industry risk change is an example of longer-term ESG risks being factored into our ratings. There is a common misconception that ratings are focused on a short time horizon of 2-3 years. On the contrary, if we have a sufficiently high degree of visibility about material factors that may crystallize well beyond that period – even a decade out or longer – we would incorporate those factors into our current ratings via our qualitative assessments.

In addition, our approach, as well as for Corporates, applies to Sovereigns, Financial Institutions, Insurance, Project Finance and Structured Finance.

On July 31, 2020, we revised positively the outlook of the European Union citing actions taken that ultimately could strengthen the EU’s governance. As well as demonstrating the relevance of ESG to supranational institutions, it illustrated the fact that when considering ESG credit factors material to credit, we analyze both the credit factors that could negatively affect creditworthiness and just as importantly those that could positively impact.

Following the change to our industry risk assessment for the oil and gas integrated, exploration and production industry we lowered our business risk profile and issuer credit rating for Exxon Mobil. The Exxon Mobil rating action is one of the nearly 2,500 ESG-linked rating actions S&P Global Ratings conducted from Q2 2020-Q1 2021. In addition to sharing ESG credit factors on individual rating actions, we summarize ESG-related rating actions globally in our “ESG Pulse,” a monthly publication for all market participants.

While the Exxon Mobil’s downgrade is a recent example, ESG-driven rating actions are not a new phenomenon; consider Drax Power Ltd (BB+/Stable). On 15 May 2009, we lowered the Drax credit rating from BBB- to BB+ stating publicly in the report “the downgrade also reflects what we perceive as Drax's rising business risk because of its focus on coal-based generation, which is subject to increasingly stringent regulatory and environmental requirements”. It was not formally categorized as an ESG-driven rating action then, as the ESG acronym was not in wide use at that point, but it demonstrates how our analysts have long incorporated ESG related risks and opportunities material to creditworthiness.

“E”, “S”, and “G” in Detail

S&P Global Ratings has published a series of studies describing how it incorporates ESG factors into its corporate ratings. Please find a few examples below.

“E” - Environmental
In How Environmental And Climate Risks And Opportunities Factor Into Global Corporate Ratings - An Update, Nov. 9, 2017, we looked at E&C factors again, and how they affected corporate ratings between July 16, 2015, and Aug. 29. 2017. For that period, we've found 717 cases where E&C concerns were relevant to the rating, and 106 cases where E&C factors--both event-driven and those occurring over a longer time horizon--resulted in a rating action. As in our previous review of E&C factors, most affected ratings were in the oil refining and marketing industry, among regulated utilities, and in the unregulated power and gas subsector.

We then took definitions of climate-related risk and opportunity set out by the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD) in June 2017 and looked at how the 106 cases where E&C risks and opportunities have had a material impact on credit quality fit into the TCFD's definitions. We give examples of this mapping exercise to provide further insight into our review.

In How Environmental And Climate Risks Factor Into Global Corporate Ratings, October 21, 2015, we reviewed 38 corporate subsectors and identified 299 cases in which environmental and climate (E&C) risks resulted in or contributed to a corporate rating revision or have been a significant factor in our rating analysis. In 56 of these cases, E&C risks have had a direct and material impact on credit quality, resulting in a rating action (outlook change, or CreditWatch action, or notching of the rating)--nearly 80% of which were negative. Most of these ratings were in the oil refining and marketing, regulated utilities, and unregulated power and gas subsectors.

“S” - Social
In How Social Risks And Opportunities Factor Into Global Corporate Ratings, April 11, 2018 we reviewed how social factors were incorporated into our analyses and how factors may have affected our corporate and infrastructure ratings between July 2015 and August 2017. We found 346 cases where social factors were explicitly identified as relevant to the rating, and 42 cases where social factors--both event-driven and those occurring over a longer time period--resulted in a rating action. The cases were spread across various sectors, with retail and restaurants, leisure and sports, and regulated utilities being most frequently affected.

“G” - Governance
Our issuer credit ratings aggregate assessments of many different variables including our analyses of management and governance, as described in our Corporate Methodology. The assessments, which range from strong, through satisfactory, fair and weak, evaluate the broad range of oversight and direction conducted by an enterprises owners, board representatives, executives and functional managers. Those assessments are a direct input into our corporate issuer credit ratings and can either contribute to a higher or lower entity issuer credit rating depending on the assessment and the entities’ other credit characteristics.

"When risks are unknown or ill-defined, the market cannot allocate resources in an efficient and profitable manner." Mark Carney, Former Governor of The Bank of England

"Environmental, Social, and Governance risks and opportunities have the potential to affect creditworthiness. At S&P Global Ratings our analysts work to ensure that we provide essential insights into ESG factors as they relate to the financial markets." John Berisford, President, S&P Global Ratings

 S&P Global Ratings has long considered Environmental, Social, and Governance (ESG) factors in its credit ratings, and we capture ESG factors in many areas of our methodology. 

Corporates
ESG factors are most often considered in our assessment of the issuer’s Business risk (specifically, its competitive position); Financial risk (through our cash flow/leverage assessment and financial forecasts); and Management and governance. 

The management and governance assessment includes consideration of environmental and social risk management, as relevant. At the industry level, we also consider industry-specific key credit factors, which may include the effectiveness of ESG risk management.

For corporate ratings, we employ our Management And Governance Credit Factors For Corporate Entities November 13, 2012. This criteria is the basis of the evaluation and scoring of the range of oversight and direction of an issuer by its owners, board representatives, executives, and functional managers. The criteria is based on the proposition that if the issuer’s management can manage successfully the issuers strategic and operating risks, its credit profile may improve. Alternatively, weak management with a flawed operating strategy or an inability to execute its business plan effectively is likely to substantially weaken the issuer's credit profile. Management and governance is scored as (1) strong, (2) satisfactory, (3) fair, or (4) weak.

Sovereigns
ESG factors are most often considered in our assessment of the sovereign’s institutional quality and governance effectiveness (typically accounting for roughly a quarter of the indicative sovereign rating). Although climate change, on average, poses a negligible direct risk to sovereign ratings on advanced economies, ratings on many emerging sovereigns (specifically those in the Caribbean or Southeast Asia) would likely come under significant additional pressure over time. Of course, in an integrated world such as today's, what happens in emerging and developing countries can have indirect repercussions for advanced economies as well, for example, through trade and migratory flows.

Financial Institutions
Our financial institutions analysis typically considers ESG factors in the context of the Banking Industry Country Risk Assessment (BICRA), risk position, and governance assessments. Our analysis of ESG risks and strengths permeates our bank rating methodology. ESG factors are also included in our assessment of a bank's risk position which incorporates risks that are not captured directly in our capital model.

Insurance
Our insurance methodology typically considers ESG factors in our (i) industry and country risk analysis, (ii) competitive position analysis, (iii) capital analysis, (iv) risk exposure analysis and (v) governance analysis.
Our insurance methodology takes a similar approach to our corporate and bank criteria frameworks embedding the impact of ESG credit factors into several aspects of the overall rating process.

Project Finance
Under our project finance methodology, ESG factors are most often analyzed in the context of a project's construction and operations phases. On the construction side, we assess the likelihood that, among other things, project construction will have no materially adverse social or cultural consequences, so that it can be completed on time and within budget; and that the project will be capable of operating as expected. If ESG factors materially affect funding adequacy, timing of completion, or the budget required to complete construction on time, we could modify the construction stand-alone credit profile (SACP). Similarly, ESG factors may also affect our operations phase SACP and forecasting of revenues, operating and maintenance costs, and capital costs.

Structured Finance
Structured finance vehicles typically comprise a pool of financial assets that generate cash flow over time. Our analytics focus on the following factors: the credit quality of the securitized assets; legal and regulatory risks; payment structure and cash flow mechanics; operational and administrative risks; and counterparty risks. Though ESG is typically not a factor directly considered in our structured finance analytics, it may have a negative indirect impact due to ESG factors that may be reflected in the credit rating on a key transaction party, such as the servicer of the pool, or the ratings on specific corporate obligors in a collateralized loan obligation pool.

Learn more about the critical role played by ESG factors in our rating process:

How ESG Factors Have Begun To Influence Our Project Finance Rating Outcomes

Environmental, Social, And Governance: ESG Credit Factors In Structured Finance
The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis

Credit FAQ: How Does S&P Global Ratings Incorporate Environmental, Social, And Governance Risks Into Its Ratings Analysis

Listed below are our ESG Industry Report Cards, published February 2020, providing insights across corporates, infrastructure, banks, insurance, and supranationals sectors, as well as project finance.

These reports cover close to 70 subsectors and more than 1,250 individual entities. We intend to update these ESG insights throughout the year in individual entity analyses, as we expect companies to increasingly focus on ESG in their communication and strategy updates. 

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