Sustainability and Integration in the Credit World

Can credit rating assessments and sustainability coexist?

According to the International Energy Agency Net Zero Emissions by 2050 Scenario, 70% of clean energy investment must take place over the next decade and largely relies on low-cost debt.

The Institute for Energy Economics and Financial Analysis produced a report assessing how credit ratings integrate ESG and how to improve their coexistence with sustainability.

As it stands, the current credit rating methodology is a disadvantage for companies that are pursuing a sustainable transition:

• The way agencies incorporate ESG into credit analysis has no effect on their conventional credit assessment. These ESG credit scores do not cause a rating upgrade or downgrade.
• While climate risks are considered material, they have little impact on assigned credit ratings today due to their relatively short-term assessment.
• What are currently deemed uncertain risks could result in a multi-notch downgrade and, eventually, bankruptcy, which can severely impact bondholders.
• Companies can have a weak ESG credit score, be carbon intensive, lack a clear carbon transition pathway and yet be assigned a high investment grade rating due to their high ability to repay their debt in the next three to five years.

This report provides possible new models for how ESG can be better integrated in credit rating assessments, including a standalone ESG risk assessment, a double rating analysis or plausible sensitivity analysis.

If we are to finance the projects required to carry out the transition towards a more sustainable economy, environmental and social issues deserve more attention from credit rating agencies.