9 August 2023

Surprise as S&P drop ESG scores from credit ratings

The retreat from ESG scoring from the credit rating agency has flagged concerns around ESG transparency and the impact of anti-ESG sentiment, Ahren Lester writes

S&P Global has dropped the environmental, social and governance (ESG) scores from its credit ratings with immediate effect, which has raised questions around its commitment to ESG transparency in bond markets.

The credit rating agency said it will no longer publish new or update existing ESG credit scores in its credit ratings with immediate effect.

S&P had provided ESG credit indicator scores for publicly rated entities in some sectors and assets classes since 2021. In May 2022, the firm argued that the scores were the "latest in our efforts to enhance transparency on the ESG-related aspects of our credit rating analysis".

The indicators had provided independent scores for the credit impact of 'E', 'S' and 'G' factors on a five point range: 1 for 'positive' credit impact, 2 for a 'neutral' impact, 3 for a 'moderately negative' impact, and then 4 and 5 for a 'negative' and 'strongly negative' credit impact.

ESG 'remains integral'

On removing the scores, however, S&P said the "dedicated analytical narrative paragraphs" on ESG in their credit rating reports are "most effective at providing detail and transparency" on material ESG credit factors. This core analytical ESG text will "remain integral" to its credit rating reports, S&P emphasised.

A source with knowledge of the decision-making process tells Environmental Finance the move followed feedback from market participants that the scores – which were meant to summarise and complement the underlying ESG analysis – were not proving the more effective way of expressing ESG factors in the credit rating process.

The source says the change was intended more as a small, technical change to how ESG is incorporated into credit ratings.

'Back to square one'

Daniel Cash – a credit rating-focused academic at Aston University – agrees that the removal of the scores was likely to have "no bearing on the integration of ESG into credit analysis within credit ratings".

Daniel Cash"They rarely use ESG as a lens and only do so really in relation to the 'G' of Governance – which is a fundamental of credit analysis anyway – or in relation to specific markets where the 'E', or to a latter degree the 'S', is clearly material," he says – such as the oil and gas and mining sectors.

Cash tells Environmental Finance that including the ESG scores in credit ratings may have increased the "manufactured pressure" on the agencies to integrate ESG factors into their ratings. Their removal, he says, is likely to have little impact on what they do on ESG in credit ratings.

"When they think [an ESG factor] is material, they will say so – and that is it," he adds. "So, back to square one in that sense."


Nawar Alsaadi – chief executive at ESG advisory firm Kanata Advisors – says that the decision could be counter-productive from a transparency standpoint, however.

Nawar AlsaadiAlthough agreeing that ESG scores have "limited utility," Alsaadi argues that the decision to stop publishing the scores was "perplexing".

"If S&P is still integrating ESG information in their creditworthiness determinations, eliminating the ratings decreases the transparency of how ESG data is being used to impact S&P credit assessments," he says.

Although the actual credit ratings applied to issuers – such as the long-term ratings, which range from the highest 'AAA' rating to 'D' – are only high-level indicators, they remain useful from a transparency perspective.

As a result, Alsaadi argues that: "If narratives were sufficient to help investors appreciate credit risk, why doesn't S&P drop its letter-based credit ratings altogether and provide narrative ratings across the board for ESG and non-ESG risks?"

"Eliminating the ratings decreases the transparency of how ESG data is being used to impact S&P credit assessments" - Nawar Alsaadi, Kanata Advisors

Alsaadi – who was previously an ESG-focused portfolio manager – tells Environmental Finance it is possible that the move was, at least in part, driven by the anti-ESG rhetoric growing in some markets, such as the US.

"By eliminating ESG ratings and keeping the ESG narrative, S&P seems to think that it can have its cake and eat it too," he says. "My guess is that S&P will neither satisfy either the pro- or anti-ESG camp with this decision."

Regulatory retreat

Another market expert wondered whether the decision by S&P to drop the ESG credit indicator was a "retreat" to the "relative safety" of unregulated markets for their ESG-related scores and analysis.

Whilst credit ratings are closely regulated, other areas where firms such as S&P are also integrating ESG scores are not under the same scrutiny – for example, second-party opinions (SPOs).

The market expert – who spoke on condition of anonymity – tells Environmental Finance: "SPOs are entirely unregulated and, furthermore, regulators trip over themselves to say they are not regulating them. Perhaps leaving them as a principal method for deciphering ESG methods, as well as distinct ESG scores, is useful to the rating agencies."

"By eliminating ESG ratings and keeping the ESG narrative, S&P seems to think that it can have its cake and eat it too" - Nawar Alsaadi, Kanata Advisors

He says this may reflect the fact that trying to better explain how you use ESG in credit rating analysis is a "fool's errand" as ESG analysis will "never be what people want from them".

Certainly, Aston University's Cash emphasises that it is "categorically" not the case that the decision by S&P to withdraw its ESG credit indicators from credit rating reports reflects a broader move by the firm away from the ESG ratings business more broadly. Indeed, he highlighted that the recent $44 billion acquisition of IHS Markit – which was completed in early 2022 – shows the opposite is true.

Indeed, the source with knowledge of the S&P decision tells Environmental Finance that the removal of ESG scores is not going to impact S&P's separate ESG scoring-related products, which are mostly located in its separate Sustainable1 business – such as its SPO reports.

Comment: ESG indicators in credit ratings: Improve not remove?

The fact that S&P decided to remove a summative ESG indicator rather than look to improve it was particularly surprising for some market participants.

Although debt investors rarely base their creditworthiness assessments entirely on the summative credit rating of an issuer, these ubiquitous credit scores have often proven useful first ports-of-call for the analysis – serving as a valuable initial screening, in some cases, and providing a useful indicator for where and when to dig deeper into credit details.

ESG indicators in credit reports could and perhaps should play a similar role as a first – but not final – part of the process for investors. Indeed, S&P has previously produced reports itself based on its ESG credit indicator scores to deliver useful, high-level analysis of ESG credit risk in sectors and economies. Insights that are often invaluable for their breadth, whilst clearly not claiming to be inexhaustible in their depth.

Jettisoning the ESG indicators, therefore, seems an unnecessary and potentially unhelpful move when potential alternatives could have been explored.

For example, a traffic light system could have replaced the alphanumeric scoring system: giving a broad picture of where and when 'E', 'S', and 'G' factors were judged to impact creditworthiness – green for a positive contribution, amber for a neutral impact, and red for a negative contribution.

Other alternatives could have been explored. For example, Kanata Advisors' Nawar Alsaadi argues that it perhaps would have been better to replace S&P's ESG model with one that provided a straightforward indication of ESG credit impact.

"A compromise approach would have been to replace the numerical ESG ratings with an arrow ratings system pointing directionally as to whether 'E', 'S', or 'G' factors are generally supportive or diminutive to the creditworthiness of a given issuer as per S&P's analysis," he says.