American policymakers are seeing red on ESG, attacking financial institutions for their sustainability practices. Now, a powerful rating agency is doing a surprising about-face on its ESG ratings.
Rating agencies evaluate thousands of companies worldwide on their efforts to promote environmental, social, and governance (ESG) standards. Among other things, these ratings serve as the basis for sustainable investment decisions. They also decide on inclusion in indexes based on ESG metrics.
A billion-dollar market has emerged around the topic of sustainability, as many investors want to invest their money according to these criteria. In Switzerland, too, there is hardly a bank left that does not have ESG investment funds in its product range.
The ratings business is dominated by the three major agencies Fitch Ratings, Moody's, and S&P, and includes ESG criteria in their credit ratings. All three have used a rating scale of one to five in recent years, with five signaling a very strong influence on creditworthiness.
Influential ESG Ratings
These «relevance ratings» can significantly impact a company's creditworthiness and influence borrowing costs. Oil companies often receive a lower rating than their financials would warrant due to climate concerns.
But factors influencing ESG ratings are highly politicized, with ESG coming under heavy fire, especially among Republicans in the US, as UBS can attest to after it was blacklisted in Texas last year.
While the world's largest asset manager Blackrock and other investment behemoths have been heavily criticized for their ESG practices for some time, the equally influential rating agencies have so far gone largely unnoticed.
Surprising Course Change
But now S&P Global is doing an about-face and moving away from its practice of an alphanumeric scale that has illustrated and summarized its ESG credit factors since 2021. In the future, a company's ESG analysis will consist only of text, it announced late last week.
The rationale for this surprising move is that narrative sections in rating reports are best suited to provide detail and transparency on the ESG credit factors that are material to our rating analysis. Lofty words, but there are likely other corporate self-interest motives behind them.
After all, critics see the use of ESG factors to determine credit ratings as a significant problem. Companies not meeting sustainability standards are effectively penalized with higher financing costs. S&P's change of course now gives the impression the rating agency is giving in to pressure from Republicans on Wall Street. This move could now also put pressure on the other rating agencies.
Zurich and Swiss Re Flee Climate Alliance
In general, the topic of ESG is having a hard time in financial conversations at the moment. After running a real gauntlet, Blackrock CEO Larry Fink has stopped using the term. Vanguard, the second-largest asset manager after Blackrock, left the Net Zero Asset Managers initiative in December.
This year, several insurance giants have withdrawn from the Net Zero Insurance Alliance (NZIA), the climate alliance of insurers, including the two Swiss industry leaders Swiss Re and Zurich. At the same time, many financial companies are facing accusations of greenwashing, a topic now on the agenda of the European supervisory authorities, which are working on appropriate countermeasures.
