Sustainable and ethical standards are in vogue, but only governance is affecting ratings, Fitch finds

Sustainable and ethical standards are in vogue, but only governance is affecting ratings, Fitch finds

More companies are adopting environmental, social and governance standards, but only governance is noticeably influencing credit ratings, according to a new report by Fitch Ratings.

Sustainable and ethical practices – known by the shorthand ESG – have become a way for companies to signal their commitment to behaviours that are less harmful to the world’s environment and its workers. Younger clients especially have shown a fondness for companies whose investments support such goals in addition to turning a profit.

The credit rating agency, however, found that less than one per cent of financial institutions have ESG factors that have actually driven a ratings change, with governance risk being the biggest issue. Governance includes such things as executive pay, audits and efforts to weed out money laundering.

“Some of the most visible credit rating actions over the past couple of years have focused on governance or conduct issues, including heightened regulatory focus on anti-money-laundering efforts,” said Kevin Duignan, global head of Fitch’s financial institutions practice. “Unsurprisingly, those same institutions saw higher governance relevance scores in our new ESG analysis.”

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The rating agency examined more than 900 banks, non-bank financial institutions and insurance companies worldwide as part of an effort to assign relevance scores for how ESG factors influence credit ratings.

Overall, nearly 20 per cent of ratings of global financial institutions are influenced by governance risk, such as a complex group structure or key person risk, according to Fitch.

The finding that governance risks had the highest influence on ratings is “not surprising” as corporate governance, management strategy and financial transparency are important considerations in its credit rating process, Fitch said.

It comes as almost half of companies in Hong Kong and China have acquired or made investments in firms with serious compliance issues and that made them more cautious than their American or European counterparts, a recent survey by the law firm Baker McKenzie found.

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Governance and group structure generated the vast majority of higher relevance scores for banks, while insurers, because of their exposure to catastrophic risks, saw a higher number of scores associated with environmental impact, according Fitch.

The rating agency assigned scores, ranging from 1 to 5, for 14 EGS criteria to measure their relevance to the ratings process, including greenhouse gas emissions, labour relations and strategy implementation.

ESG factors are expected to be an important measure for financial firms in the future.

The United Nations has called for more private sector investment to achieve a series of sustainable development goals by 2030, including addressing climate change, poverty and education.

At the World Economic Forum in Davos, Switzerland, last month, UBS unveiled a new pilot programme designed to allow clients to better measure their investing preferences against their sustainability goals. The programme is expected to be introduced in the first quarter.

Fitch said that its relevance scores will be used in the future to provide a “deeper insight” into why ratings change and would “make it much more transparent where ESG risks have an impact on a rating decision”.

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