Rating agency agreement “critical” for ESG investment

The decision of Moody’s, Standard & Poor’s, China's Dagong Ratings and other credit rating agencies to sign a statement on environmental, social and governance (ESG) requirements in ratings marks the latest sign of the concept gaining international traction.

China in particular appears to be increasingly keen to engage, largely because of the consequences of its own poor track record in these areas, said Jessica Robinson, Asia ex-Japan head of Principles for Responsible Investment (UN PRI).

Other participating rating agencies include Malaysia's RAM Ratings, German firm Scope and Brazil's Liberum Ratings. In addition, 100 investors representing $16 trillion in AUM signed the statement (a copy of which can be downloaded here), which was initiated by UN PRI, a United Nations-backed agency focused on raising ESG standards.

“Pension funds have on average one-third of their portfolios in bonds and insurers have more, so it was critically important to get the rating agencies involved, given their importance in this market,” Hong Kong-based Robinson told AsianInvestor.

“Investor demand was already there and many have signed this statement out of concerns about climate change, water and corruption, among other issues," she added. "This is designed to be a step in ESG being material to investors.”

The inclusion of Dagong as one of the signatories might raise some eyebrows, given China's well known corporate governance limitations. These extend to local rating agencies, which rate the vast majority of local renminbi-denominated bonds between AAA to AA-, despite many highly-rated companies being heavily indebted and expectations mounting that China's default rise will spike this year and going forward. 

However, Robinson said a more positive attitude from the People’s Bank of China, the country’s central bank, in particular, was helping foster the concept onshore. “A lot of things are going on with China behind the scenes, especially in relation to the PBoC, that is making this [boosting awareness of ESG] easier,” she noted. 

China's changing attitude
China certainly has problems to address in this area. Fraud and graft issues frequently bedevil corporates, while poor enforcement of environmental rules around dirty industries has caused chronic pollution to the country's groundwater and soil, as well as raising air pollution to dangerously high levels some days in major cities such as Beijing, causing health and mortality issues. 

However, Robinson believes the prevalence of corruption and pollution in particular is fostering local resentment, which is pushing the government and state-controlled agencies to engage with ESG requirements.

She pointed to the PBoC report 'Establishing China's Green Financial System', published in April last year. It made 14 recommendations on what should be done to improve environmental standards through the financial system, the last of which was entitled 'Require environmental disclosures by listed companies and bond issuers'.

One of UN PRI’s next goals will be to work with Chinese authorities and corporates to try to raise levels of green bond issuance, ideally using Hong Kong as a hub for such deals. “We need to start lobbying Chinese companies to come down and issue here,” she told AsianInvestor. “There's a lot of momentum.”

Another challenge will be to get the Hong Kong Monetary Authority to be as progressive as the PBoC appears when it comes to embracing concerns of ESG, particularly when it comes to environmental concerns. “It's hard to have a conversation with the HKMA [about it], even though it says it's a systemic risk,” Robinson admitted.

Global initiative
The statement marks the latest in an array of global efforts to raise ESG as an issue among asset owners and fund managers, as concerns continue to mount about global warming and the impact of pollution.

Robinson said it had taken a few months to get the rating agencies to sign the statement. “The challenge when talking about systematic considerations is not to be prescriptive, but to consider a diversity of assets globally,” she noted. “The idea is to develop a [ESG] framework, look at the issues and have ESG data [on your investments] so you can respond when you are questioned about them.”

The longer-term hope is for rating agencies to develop their own information-collection processes, and make rating changes that at least in part take into account such ESG data and the risks it reflects.

Brian Cahill, managing director for Asia Pacific corporate and financial institutions at Moody's, said the agency had signed the agreement as its latest step in raising its profile in addressing ESG.

"The feedback investors generally offer us is that they are under increasing pressure to explain how they consider ESG in their investment approaches, particularly in equites but increasingly in fixed income too," he told AsianInvestor. "As a means to validate their approach they want credit rating agencies to consider it as well."

Cahill noted that investors increasingly want to see a structural approach to ESG, but that Moody's had no immediate plans to introduce specific ESG scores in its ratings. However, he said the agency has identified 11 sectors most at risk of regulatory changes following the landmark Paris Climate Agreement. This was signed by 175 countries on April 22 with an aim to cut global carbon emissions. The agency has also conducted other reports on environmental issues (which can be found here).   

Moreover, pressure is mounting on asset owners to consider climate change, environmental damage and governance issues with the companies whose assets they buy.

The Asset Owners Disclosure Project issued a report this month that said 51% of asset owners were now taking some action in managing investment climate risk, but that up to $14.3 trillion of institutional investors' assets were being managed without any consideration of the impact of climate change on these portfolios.

PRI and other agencies and fund managers advocating ESG standards have been keen to stress that investors and corporates should not consider such issues as 'doing the right thing' or acting charitably. These are attitudes that some institutional investors balk at, considering them less important than delivering promised returns.

Instead, they argue, investors and corporates should view exposure to ESG issues from a risk perspective, particularly given the rising publicity and regulatory pressures across the world relating to these issues.