World Climate Foundation
Providing Insights to Investors on Company Journeys Towards Net Zero
An interview with Andrew Steel, ESG Lead, Sustainable Fitch
Demand from investors for more information about a company’s environmental, social and governance (ESG) practices continues to increase as the world attempts to transition to a low carbon future. In response to this, large credit ratings agencies have started to offer information and opinions beyond pure credit.
At COP27 and World Climate Summit 2022 in Sharm el-Sheikh, Sustainable Fitch will put a spotlight on the developments and innovations that they are seeing in sustainable debt, as well as talk about how Sustainable Fitch plans to contribute to investor efforts around sustainability and net-zero. In a Panel Session on 13 November, Andrew Steel, ESG Lead, Sustainable Fitch, will discuss how Fitch, as part of the global media and financial services business Hearst, has started examining and revising their business, as well as what they are seeing from other businesses globally.
In this interview, Andrew Steel explains how and why Sustainable Fitch has moved beyond credit ratings to ESG ratings, and why this is important as the world transitions to a low-carbon future.
- Sustainable Fitch has recently announced the launch of its ESG Ratings products. Why are you launching these products?
After we integrated the transparent display of ESG risks into Fitch’s credit ratings in 2019, we saw a rise in the number of asset managers and owners asking us for detailed ESG ratings which went beyond financial materiality to include analysis on ESG performance, impact and outcomes. This gap in the fixed income market led us to build a framework for ESG analysis which captures these risks for both entities and individual debt instruments.
We started from the fundamentals, by building an analysis framework from the bottom-up that provides asset owners with a modular, granular data set and commentary with a lot of emphasis on activities and outcomes, as well as aspirations. While the ESG Ratings will positively factor in science-based targets, they also recognise the impact of the business’s current activities. To get a proper cross-comparison of entity ESG performance between sectors, it is crucial not to under-emphasise current activities, or use ‘best in sector’ scoring where significant activity impact differentials exist.
We are aiming for near full coverage of the labelled bond universe – around 900 entities and nearly 2,000 labelled and sustainability-linked bonds – by mid-2023.
- What interaction have you had with issuers on the ESG ratings?
For every entity that we cover, we share the report we produce for additional information, commentary and feedback. The level of interaction from issuers has been much higher than we anticipated: over 50% actively engage with us on the reports that we are producing. I think that’s the statement to the insights, quality and granularity contained within the reports.
Beneath the overall E, S and G factors, there are a large number of sub-factors, supported by a number of data sets. For instance, if an investor is interested in something as specific as environmental supply chain management, they can see a separate score and commentary for that and compare it with other entities we rate. Our ESG Ratings provide a very high level of granularity.
- The ratings are particularly aimed at fixed-income investors. How has that guided the approach you have taken?
The detail and granularity we provide in our entity-level ESG Ratings mean they can be used equally by debt or equity investors, allowing investors to pick and choose the aspects that are relevant to them. Our bottom-up approach in building the ESG Ratings also allows for easy alignment with different frameworks, whether the Sustainable Development Goals, ICMA principles, EU Green Bond Taxonomy, or any other requested taxonomy.
But for fixed income investors, it is very much about the instrument-level ESG Ratings. There are two things that differentiate them. The first is that we cover all types of labelled or sustainability-linked debt instruments, not just bonds. The second is that we can also provide an ESG instrument rating for an issuer’s conventional bonds. This takes account of how they are aligned with its entity-level ESG framework and ESG policies, long-term aspirations and targets. That allows an investor to gain insight into whether, for example, a conventional bond from a telecoms company might better fit its ESG portfolio than a green bond from an oil company.
- In addition to ESG ratings, you also produce ‘climate vulnerability scores’ looking at longer-term climate risk. How does this work?
“When you start to look longer-term, sector risk profiles may change significantly, depending on what type of climate scenario emerges, and influence how companies need to prepare for future risks.”
- Andrew Steel, ESG Lead, Sustainable Fitch
We have embedded our credit based ESG Relevance Scores into Fitch’s credit ratings to provide a view on the financial materiality of ESG risk issues on a value-neutral basis. Lots of companies, however, are very good at managing near-term environmental and social risks to ensure there is no financial impact. However, when you start to look longer-term, sector risk profiles may change significantly, depending on what type of climate scenario emerges, and influence how companies need to prepare for future risks.
For our Climate Vulnerability Scores, we picked a 2°C scenario and looked at what actions will be needed for countries, industry sectors and manufacturing processes to become net zero. An entity that may be effectively managing its environmental risk today might face a longer-term scenario where it becomes exposed to legislative changes that might shut part of its business down or dramatically change its cost profile.
We can then use this information to start to connect credit impact with ESG performance. The short-term, value-neutral, financial materiality of ESG risks is displayed in Fitch’s credit ratings; the potential long-term credit risk from climate change is shown in the Climate Vulnerability Score; and the ESG Ratings show if and how the company is recognising and dealing with these longer-term risks. The granularity enables investors to either agree with or make their own alternative assumptions about which scenarios are likely to transpire.
- What are the next steps for the ESG ratings product?
We are also building out coverage of the leveraged finance market, working with a significant number of European and US managers. We are nearing the completion of coverage of the EMEA leveraged finance market and have now started to work with managers on the US market. Once we have completed ESG ratings for the labelled bond universe, we are looking at potentially extending coverage to some of the conventional bond indices. Ultimately, over the long term, we would like to cover the entire bond universe, but we will be guided by the immediate requirements of investors.
“Commitments need to be real and timebound, as well as realistic, given the timeframe for achieving net zero is closing rapidly.”
- Andrew Steel, ESG Lead, Sustainable Fitch
- What would you like to see at COP27 and World Climate Summit?
I would like to see further progress on the retirement of coal generation in developing markets, and the development of new clean energy resources with associated funding commitments. Actions continue to be slow on pledges that were made at COP26, and the details and aspirations for commitments appear to be waning. The war in Ukraine has clearly impacted and disrupted many governments' plans and resulted in some short-term reprioritisation away from climate change action. I would also like to see a renewed focus on equitable global decarbonisation strategies that create common ground for both developing and developed market countries, as a priority for COP27. Additionally, commitments need to be real and timebound, as well as realistic, given the timeframe for achieving net zero is closing rapidly.
About Sustainable Fitch
Sustainable Fitch is the ESG ratings division of Fitch Solutions. Fitch Solutions is the commercial business arm of Fitch Group. Fitch Solutions fuels better-informed risk and strategy decisions by providing investors with reliable data, insightful research, and powerful analytics across global markets and macroeconomic environments.
Learn more: www.sustainablefitch.com
About the author
Andrew created Sustainable Fitch, a new business line for Fitch Group, providing ESG rating products and services. Andrew has held several senior management positions within Fitch since 2004. Prior to that, he worked in investment banking, M&A, corporate treasury, private equity and advisory roles.