4 October 2021

Entering the ESG ratings fray

With its new ESG Ratings product, Fitch claims to offer the market's most comprehensive approach to entity, debt instrument and ESG framework ratings. Environmental Finance talks to Global Head of Sustainable Fitch Andrew Steel

Andrew Steel

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Environmental Finance: What is the thinking behind Fitch's new ESG Ratings product?

Andew Steel: We are an investor-focused business, and investors have been increasingly asking for a transparent, comprehensive and comparable methodology for ESG, that looks beyond instrument labeling to the ESG fundamentals. So we've spent the last 18 months talking to investors and developing a framework that will provide a suite of products that can actually deliver on that ask.

We've developed a comprehensive product that provides ESG ratings for entities, individual debt instruments – whether conventional or ESG-labelled bonds or loans – and for ESG frameworks, similar to second-party opinions.

EF: What exactly does the ESG rating measure?

AS: For entities, it assesses the overall ESG credentials of the business. It looks at its current activities, their contribution to revenues and profitability, and it assesses their impact from an environmental and social perspective. Here, we're measuring impacts using classifications such as the EU Taxonomy for environmental risks and the Sustainable Development Goals when it comes to social risk. Then we assess the future trajectory of the business. At the entity-level, we focus on activities, impacts and outcomes.

When it comes to debt instruments, we're focused on their purpose. If they are labelled or KPI [key performance indicator]-linked bonds, we look at how the use of proceeds are managed, how projects are selected, whether they are additional, etc. We also assess conventional bonds, which allows investors to compare an unlabelled debt instrument from a pure-play renewables company, for example, with a green bond from and an oil and gas major.

EF: What differentiates the offering from existing ESG rating products?

AS: A lot of the products originally developed for ESG were geared towards equity investors and were focused on the entity level. We've tried to develop something which is specifically focused on fixed income investors. Also, the market is currently somewhat fragmented between those providing second-party opinions and those offering entity-level ratings, with those ratings often just cascaded down to individual debt instruments.

We think that, in the future, when investors look to invest in any debt instrument, they will consider both its financial and ESG aspects, and what those mean for the issuer in the future. If that information isn't available, there will be a very limited universe of investors prepared to invest in that debt. We wanted to build something that is future proofed and that, over time, we can apply to the entire fixed income market.

In addition to being comprehensive, the ESG Ratings product is modular, allowing users to just focus on, say, environmental aspects, or just to look either at the entity as a whole, or its ESG framework. The ratings also replicate the granularity that investors are used to seeing in our credit ratings. And they're very transparent; all our qualitative commentary is clearly backed with the source data.

EF: What challenges did you face in coming up with the ESG Ratings product?

AS: The devil is in the detail. We spent a lot of time creating the analysis framework from the bottom up. There's a lot of emphasis on how you score individual aspects of risk, with a focus on what investors are trying to look at and measure. That's why there's a much higher weighting on impact and outcomes compared with policies and procedures.

There were other challenges in coming up with a framework that creates an absolute scale, allowing cross-comparison between entities and instruments. That involved thinking very carefully about the impacts of different industry sectors.

EF: How do you see the product developing over time?

AS: As taxonomies continue to develop and change, we would expect to refine some of the alignment sections that we have, but we wouldn't envisage any fundamental alterations to the analysis framework. We are creating variations on the framework to take account of things such as assessing fund managers, money market funds, and leveraged finance entities, or structured transactions backed by collateral. Sovereigns will require a slightly different approach as well.

We have developed this as an investor-led service, which puts an emphasis on developing comprehensive datasets – taking an issuer-pays model tends to skew coverage towards issuers who have good ESG credentials. Once we've covered the ESG-labelled market, which we expect to do by the end of the year, we'll next look at addressing the indexes or industry sectors that investors are particularly interested in.

That said, we also offer issuers in-depth ESG ratings, either at the entity, framework or instrument level. These can prove very useful when marketing bonds – and we've been inundated with enquiries since the launch.

EF: Fitch has also launched the Sustainable Fitch unit, which you're leading. What was the motivation for that?

AS: The main reason was to create a distinct vehicle through which to launch our ESG focused products. It also has a group-wide remit to develop and coordinate the range of ESG initiatives that we have underway – covering research, ESG training programmes, our covenant review business, etc.

We see this as being fundamentally a very large part of our business in the future. In the long term it has the potential to be as large as or even larger than our credit ratings business, because there is no restriction on the types of instruments or the type of entities that we can cover.

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Andrew Steel
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