- S&P has decided to stop serving simple ESG scores linked to credit ratings analysis.
- The decision has been rejoiced by right-wing commentators as a victory.
- A credit rating is about ESG regardless. S&P’s decision does not change that.
The recent announcement that S&P Global Ratings (S&P) would cease to use ESG scores to support investors in the management of their bond portfolios only after two years was seized upon by those seeking to “end ESG” with aplomb.
Categorically, the ratings agency will continue to factor in ESG into its credit scoring; it is just an investor must make the effort to read its analysis within the body of a credit report to learn its position.
But that didn’t stop prominent political figures from utterly misinterpreting the event.
Jimmy Patronis, chief financial officer of the State of Florida, and well-known anti-ESG campaigner, said: “There was a real risk that these debt ratings agencies were going to shove ESG down states’ throats. The threat was real: adapt ESG criteria in your investment decisions or we’re downgrading you. The S&P abandoning this woke-virus helps removes that threat. Huge victory.”
As far as political point scoring goes, this is exceptionally trite. And completely predictable given how childish the discussion around ESG is in the US.
Admittedly, S&P did not help themselves. The press statement, issued on 4 August, was cursory at best. Extending to a mere three paragraphs – despite its significance – the ratings agency chose not to provide an explicit explanation of its decision, other than to say it believes that a narrative explanation will be “more effective” in articulating ESG-linked factors that could influence credit scores.
In the vacuum of any substantial justification, it is easy to fill the void with conjecture.
Which may be why an unnamed source at S&P confided in Bloomberg a few days after the announcement to abjectly deny the decision was in any way linked to political pressure or “legal threats”, the latter being a reference to accusations made by a handful of US states that S&P is somehow in breach on consumer protection laws for promoting ESG.
S&P: political pressure?
The real reasons for the decision may well sit somewhere in the middle. The huge pressure rating agencies face, especially in the US, could be cause for backing away from activity that places them under further scrutiny.
The truth of the matter is that ESG scores have long been plagued by criticism and not by institutions with a political axe to grind.
Providing a rudimentary score that somehow encapsulates a host of complex and interconnected ESG factors that can determine the likelihood of a payment default was never going to prove very popular or easy. Many investors found the 1-5 score difficult to use alongside the established credit rating. What did it mean that a company had a low ‘E’ score but a AAA rating, for example?
In this sense, Capital Monitor believes the decision should prove beneficial to the ESG cause. As anyone who isn’t drinking the US Republican Kool-Aid will no doubt appreciate, good corporate governance, efforts to mitigate or adapt to a changing climate and incorporate evolving societal influences into your business practices is going to be a better run company than one that does not.
A credit ratings score should de facto be about ESG. And the more it is embedded in the traditional score, the better for investors.
And anyway, because S&P intends to continue to provide ESG analysis and insight, investors will not be short-changed.
In fact, feeding them simplistic scores, rather than impressing on them to go and read a credit report in full, is recipe for trouble anyway. If we all care about how ESG is affecting businesses, is it too much to ask to spend an extra ten minutes working through the conclusions of an analyst’s report?
As Capital Monitor has argued, the ESG real battleground is the time horizon on which a credit score is predicated. Given the nature of aspects of ESG, some of the heavy-duty risk associated with climate change, such as transition risk, may end up outside the scope of a ratings assessment because it is too far in the future.
Ratings agencies are cognizant of this issue, but are as yet unwilling to alter their methodologies. In the case of Fitch Ratings, it provides alternative reports that do factor in long-term ESG transition risks but make clear these are not credit scores.
In time, this too may prove an unnecessary overlay as more research and analysis is conducted on how ESG transition influences creditworthiness. Much in the same way as we hope that pathetic tribalism on matters as hugely important as ESG will soon be a thing of the past.[Read more: ESG ratings]