Fitch Ratings’ announcement that it is considering the inclusion of climate transition risks in its credit scores has been welcomed as “a logical step” as the firm seeks to bring greater transparency to a maligned part of the ESG data and metrics space.
The London- and Paris-headquartered ratings company published a “discussion paper” last week, suggesting it would use its own Climate Vulnerability Scores (Climate.VS) in calculations of companies’ creditworthiness. Climate.VS is Fitch’s tool for measuring the risks to which companies are exposed by their zero-carbon transition plans.
If the proposal is accepted, it would represent major step in linking climate risks to credit risk scores through quantitative analysis at a time when ESG ratings themselves are under fire for inconsistency and a lack of data transparency. The integration of credit and ESG risks are seen by many investors as key to enabling better, more holistic decision-making.
Credit ratings companies “are not surprisingly well suited to come up with climate risk assessments in the first place because they are the ones who obviously know all those companies and locations because they need them for credit risk considerations”, Volker Lainer, head of data connections, ESG and regulatory affairs at data management company Golden Source, told ESG Insight.
Screening, Analyses
Climate.VS would be used to screen entities for their exposure to climate transition risks and those that fail to clear a specific threshold would be further analysed and subjected to consideration by Fitch’s credit rating committees. Their performance scores will then be included in the final ratings report.
“The scores are focused on transition rather than physical risks, as we believe climate-related policy, market and regulatory risks are likely to have a more severe credit impact on corporates as a whole in the first half of this century than the physical risks from climate change itself,” Fitch said.
“This proposal will put Fitch Ratings, and our users, in a stronger position to identify and react to these changes.”
Climate.VS, which was launched last year and covers 13 non-financial corporate sectors, has been updated for this exercise, Fitch said.
Controversy
The role of credit rating firms in formulating ESG risks has been shrouded in controversy because of inconsistencies in their results. Investors argue that the fact each firm can arrive at widely differing ratings for the same entity makes it impossible for them to compare and properly assess potential investments. Critics, meanwhile, say such inconsistencies enable greenwashing and that the ratings reports are “black boxes” that offer little transparency into how ratings are derived and what data is considered.
Regulators in Europe, the UK and the US have stepped into the debate, announcing last year that they would consider bringing the ratings firms under their scrutiny to ensure ESG scores are comparable and transparent.
Inclusion of ESG in credit ratings is seen by some as a suitable compromise, bringing nascent sustainability metrics into established and trusted creditworthiness calculations. S&P Global and Moody’s also consider climate factors in their credit analyse.
Reference Data
Golden Source’s Lainer said the consideration of ESG metrics in the big ratings firms’ credit analyses indicated that sustainability data was now regarded as equally important as regular financial market data.
“The more it becomes reference data, the more people realise that this core ESG data needs to be looked at in conjunction with adjacent datasets, and credit ratings are such an adjacent dataset,” he said.
“If I wanted to build a portfolio according to particular ESG criteria I wouldn’t look at that in isolation,” he said, explaining that to do so would run the risk of later discovering “that some of those fantastic, super-sustainable investments unfortunately have a really bad credit rating, or one of them is even on the sanctions list.”
Fitch stressed that the inclusion of Climate.VS metrics in its credit analyses would not change a rating nor did it indicate that the company had adjusted its ratings calculation methodology.
Instead, it the move is intended to be used to assess climate change risks, which Fitch said will be a major part of its analyses soon.
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