Sustainability Credit Warning For Underwriters

Rating Firm Fitch has warned insurers need to understand the issues around sustainability before they become an anchor to credit profiles.

The firm has issued a report in which it identified six key environmental, social and governance (ESG) trends for 2020 that are relevant to credit ratings, supported by Fitch’s proprietary ESG Relevance Scores (ESG.RS) as well as research and insights from over 1400 credit analysts in 30 countries.Fitch said the trends highlight how ESG considerations are starting to affect credit profiles, through tightening of policies, societal pressures or changes to how financial markets allocate capital. However ESG issues remain only relevant to credit ratings in a limited number of cases (around 14% of issuers, programmes and transactions scores across analytical groups), as many of these factors have emerged gradually so far.

“Heightened public debate on a range of ESG issues highlights the potential for a sharp shift in policy direction – with consequences for credit ratings,” said Mervyn Tang, Fitch’s Head of ESG Research.

Fitch added that ESG-driven risk allocation decisions from banks and investors are affecting the ability of corporates to refinance, in at least one instance even driving a credit rating downgrade (CoreCivic, Inc., the private prison operator). Survey evidence indicates a significant number of banks have now included ESG considerations in their risk management frameworks, and an increasing number of funds are explicitly adopting ESG mandates.

However, it does not expect the establishment of the EU’s Taxonomy for Sustainable Activities to have credit implications in the short-term, but warned it could lay the foundation for a sustainable finance ecosystem to evolve around.

“Such activities may also become the target of more direct financial incentives should policymakers take a more aggressive approach to directing capital, such as the incorporation of sustainability into prudential requirements,” it added.The gap between government pledges to cut carbon emissions and policies now in place highlights the risk of a sharp shift in the policy landscape.

“Climate regulations have only been relevant to credit ratings for a handful of sectors such as European utilities and autos so far, with existing policies often lacking financial impact or immediacy. Fitch views carbon pricing schemes as the most convenient lever for policymakers to expand the reach and impact of climate policies.”

The consequences of widespread changes to data protection regulation globally will become clearer as more examples of fines and penalties for data breaches emerge added Fitch. These regulatory changes are likely to result in bigger fines than in the past. Few cases of data breaches have been relevant to credit ratings so far, as the overall impact on companies has generally been low and often mitigated by insurance.

Fitch said it expects perceptions around income inequality and broader economic unfairness to continue into 2020, shaping the policy agenda. This can have broad credit implications across analytical groups, from higher risks of social unrest to political and societal pressure to contain prices of necessities such as drugs and fuel. This is already evident in a number of countries, such as the recent spate of political unrest in Latin American countries.

“Governance is and will likely continue to be the most dynamic ESG factor, driving most changes to ESG Relevance Scores so far,” it added. “This is consistent with earlier findings that governance issues are most relevant to credit ratings in all analytical groups. The types of issues driving governance ESG.RS changes vary widely, from conduct issues for Australian banks to changes in board directors and management.”