A number of disconnects exist between investors and credit-rating agencies when it comes to environmental, social and governance factors, said a new report by the Principles for Responsible Investment.
The report outlines how investors and credit-rating agencies are taking ESG factors into account in credit risk analysis.
The report said a particular disconnect exists when it comes to views on the time horizons over which ESG factors should be considered. "Investors and (rating agencies) struggle to agree on what is a reasonable time horizon to consider," said the report. "Investors tend to align their time horizons with their investment objectives: some buy and hold long-term bonds until maturity (while) others trade more frequently."
There may be a disconnect for buy-and-hold investors since a credit-rating agency's long-term rating "may not be forward-looking enough," and for more frequent traders, "it could be too long term."
The report found that both investors and credit rating agencies are ramping up their efforts to take ESG factors into consideration in credit risk analysis. Agencies already consider many factors when conducting analysis, but need to better communicate this work, while investors do not consistently take ESG analysis into account in their credit risk assessment, the report said. "It can be advisory in nature and the responsibility often falls on ESG analysts alone to raise red flags. Hence, at this stage, full ESG integration appears some way off," the report added.
"The dial is definitely beginning to move in the right direction, but we are not at a stage yet where ESG factors are systematically included in credit risk analysis," said Carmen Nuzzo, PRI senior consultant, credit ratings initiative, in a statement accompanying the report. "ESG integration is still perceived as a 'nice-to-have' rather than a 'must-have.'"
The report is the first in a three-part series by the PRI, and forms part of its work to enhance the systematic and transparent consideration of ESG issues in credit assessments of borrowers in fixed-income markets. The second and third parts will provide more in-depth coverage on existing challenges and future opportunities.
"Shifting Perceptions: ESG, Credit Risk and Ratings – Part One: The State of Play," is available on the PRI website.