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How does ESG change credit risk? India Ratings wants to spot the link

More and more, analysts and investors are trying to find out how ESG factors relate to credit risks for a company.

While ESG ratings can help assess a company’s sustainability over the long term, they continue to lack common assessment ground, making it harder for investors to understand them.

Credit ratings, on the other hand, have set standards that have been harmonized over the years. The United Nations Principles for Responsible Investment have also urged credit assessors to start incorporating ESG criteria into rating decisions, as these would be important in assessing borrower creditworthiness and the likelihood of default.

Globally, credit rating providers like S&P, Fitch Ratings and Moody’s Investors Service already incorporate ESG factors into their rating actions. However, it is relatively newer for India.

In addition to India Ratings, Acuite Ratings & Research has also started incorporating ESG factors into its credit ratings. They will disclose the “financial materiality” of ESG issues to credit ratings in their analysis. Crisil Ltd. has its own ESG ranking separate from credit ratings.

That’s not to say that ESG factors weren’t included in the rating action earlier. After all, ESG risks are business risks that credit assessors need to consider anyway.

“What we’re trying to do now is dig deeper into the sub-factors,” said Valecha. “If we can focus on the ESG factors that play a role in ratings, then investors can decide whether it makes sense to them or not, and ultimately decide to invest in this company.”

“Investors can take binary calls on ESG like not wanting to invest completely in coal and invest only in green technologies. But when a decision needs to be made where you need to determine the risk premium for lending to a company with ESG issues, then such disclosures can help them decide how to assess that risk, ”said Valecha.

“This is how investors have primarily used it globally, in terms of our parent Fitch’s experience.”