Fitch Ratings says that its analysis of ESG Relevance Scores shows clear evidence of sectoral and regional patterns for how environmental, social and governance (ESG) factors affect non-financial corporate credit ratings. Identifying where ESG risks are unique to the issuer versus part of sectoral and regional trends may help to explain more clearly the transmission channels linking ESG factors to credit risk.
Emissions regulation is the main driver of environmental credit issues. More than half of credit-relevant environmental elements are related to greenhouse gas emissions, with the utilities and auto sectors most affected by tightening regulation. Operational event risks, such as oil spills and disruptions from extreme weather, are more common for the natural resources sector but, overall, are less frequently credit-impactful.
A number of environmental risks are more region-specific, such as water performance tied to regulatory financial rewards and penalties for UK water utilities, or potential wildfire liabilities for Californian electric utilities. Social risks are more relevant for credits in developed markets (DM), with consumer trends being a key driver.
Health-related shifts in consumer preferences and regulation affect a wide number of issuers in the food, beverages & tobacco sector, as does scrutiny over healthcare costs and drug pricing for the pharmaceuticals industry. Apart from consumer trends, social risks are more frequently relevant for the natural resources sector through public opposition to projects. While social risks are less relevant for emerging markets (EM), social and political pressure on consumer pricing is a common feature for some EM corporates.
Governance trends vary more by region than by sector. Issuers with complex group structures and relatedparty transactions are more common in DM, partly driven by the structure of firms in sectors such as the US midstream energy sector. Lack of transparency, lack of board independence and key person risks are more common in EM.
Mentions of alleged corruption, fraud and other violations are also more common in EM, particularly in the Americas. Entities with multiple ESG drivers commonly include at least one governance element. Two or more ESG elements are relevant for 129 of the initial sample of 1,534 published corporate issuers, with governance elements most often jointly relevant. Credit risks related to operational execution, environmental-related operational failures and incidents of alleged corruption, fraud and other violations most frequently appear in combination with governance issues.
A significant number of EM issuers also face multiple governance issues. Relevance scores tend to be higher where there are strong financial linkages with ESG factors. For example, regulatory penalties for poor operational performance increase the relevance of water management for UK utilities, while the implementation of carbon pricing increases the relevance of the environmental impact for electric utilities.
Alleged corruption, fraud and other regulatory violations are most commonly mentioned for ESG elements scoring ‘5’. Other high profile events, such as tailing dam collapses, emissions scandals or lengthy operational disruptions are also highly relevant to credit ratings.