The PRI has released its third part of its report into ESG, credit risk and ratings recommending credit rating agencies flag up ESG risks and opportunities in reports.

The report focuses on the emerging solutions discussed via a series of global forums organised by the PRI to address four apparent disconnects - areas where fixed income (FI) investors and credit rating agencies (CRAs) had different views on how to consider ESG factors in credit risk analysis.

The disconnects were originally identified in part I, describing the state of play of ESG consideration in credit risk analysis. Part II focused on roundtable discussions around those disconnects, including the materiality of ESG factors to credit risk, the relevant time horizons and differences between a “built-in” and an “add-on” approach.

The third part report found that some of these disconnects were misconceptions linked to FI investors’ and credit rating agencies’ different objectives; some disconnects were the result of a lack of investor awareness of the improved CRA focus and analytical resources on ESG topics; and some disconnects are in fact shared challenges that credit practitioners face as both sides build a more systematic framework.

As a result the PRI believes that both sides need to categorise ESG factors by type, relevance and urgency; conduct regular retrospective analysis to assess how their relevance evolves; use sector, scenario, sensitivity and stress-testing analysis to monitor long-term risks, incorporate uncertainty and focus on drivers of potential outcomes; provide ongoing training to analysts; and engage with issuers on ESG topics to improve awareness, disclosure and transparency.

“Since the launch of the initiative, many investors and CRAs have made progress on some aspects of the recommendations; the largest CRAs in particular have embarked on a race to the top,” said Carmen Nuzzo, PRI senior consultant, ESG in Credit Ratings Initiative. “However, they should not rest on their laurels; more work is needed to assess the link between sustainability and credit quality.”

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