Credit Ratings Deserve ESG Risk Analysis, Not ESG Scores
KBRA’s Approach to ESG Risk Management
In just 10 years, by remaining committed to investors’ need for fundamental credit risk analysis, KBRA has grown into a global full-service rating agency. We have rated over 40,000 transactions, 2,800 entities, and over $2.25 trillion of debt across almost every sector. KBRA has also become a proven thought leader across a broad landscape of corporate, financial, and government (CFG) credit topics. KBRA has demonstrated a willingness to disrupt the status quo with more incisive analysis that is focused on our core mission—the assessment of default and recovery risk. We believe this approach serves markets better than the tendency by some to rely on old habits that have become detached from actual default experiences, or sometimes overreact to headlines. Consistent with this preference for fundamental credit rigor, KBRA has taken a decidedly different approach to incorporating environmental, social, and governance (ESG) risk analysis into our credit ratings, especially when compared to other rating agencies.
In KBRA’s view, there are comparatively few ESG factors that materially impact the risk of default and recovery over the short to medium term for most CFG debt issues relative to the many ESG factors that are important to various stakeholders. Institutionally, KBRA embraces numerous ESG initiatives including efforts to improve the quality and frequency of issuers’ disclosure. KBRA also embraces efforts to mitigate the effects of climate change and to improve social and racial equity. As a signatory to the UN Principles for Responsible Investment, KBRA publicly demonstrates this commitment to seeking a more sustainable financial system. In addition, we are committed to making our organization more diverse and inclusive, from working with experts on unconscious bias training, to partnering with HBCUs such as Howard University in recruiting talent to help shape the next generation of leaders in the credit market space. At KBRA, we pledge to continue looking for ways to make diversity and inclusion a reality.
And while many ESG factors play an important role in how we manage our business, and a growing role in helping investors preferentially allocate capital, we believe the role of analysts at a credit rating agency is to remain focused on ESG factors that are material to credit. Further, KBRA believes that the distinction between ESG factors that are credit-relevant or not is best accomplished through fundamental, bottom-up credit-by-credit risk analysis, rather than through the collection of often irrelevant ESG data and/or the creation of ESG scores that are burdensome to analysts and issuers. In our view, ESG scores based on subjective metrics that are not correlated to credit risk have no place in the credit rating process. Instead, KBRA analysts identify and integrate credit-relevant ESG factors through the lens of risk management analysis. We call this approach, ESG Management.
Through the lens of ESG Management analysis, KBRA integrates relevant ESG issues into our credit analysis without having to veer into subjective selection, scoring, and weighting of ESG factors that are not meaningfully credit-relevant. Our dialogue with issuer management teams on these topics increases our understanding of risks that may be around the corner, and/or strengths that go un-noticed in others’ subjective ESG scoring rubrics, a process we believe leads to higher quality disclosure. While ESG scoring rubrics normatively choose and weight certain ESG topics (but ignore others), KBRA’s approach allows for the analysis of those topics most relevant to a given issuer—and most impactful to credit.
KBRA believes that credit-relevant ESG risks and opportunities are unique to every rating and issuer. Our approach to evaluating the management of ESG issues is a bespoke and dynamic process.
KBRA does not deploy subjective value-based ESG scoring rubrics, and we do not distract issuers and investors with the burdensome collection of ESG data that are not impactful to credit.
KBRA believes that ESG factors that impact credit risk need better disclosure and are best examined through the lens of risk management analysis for CFG debt issues and issuers. Under our ESG Management framework, we seek to understand the ways that a CFG issuer’s management team can identify, address, and mitigate relevant ESG risks (or capitalize on opportunities), and/or the ways a specific transaction structure can mitigate these risks.
Consistent with how we assess default and recovery risk, we view the management of ESG factors as a dynamic process along a continuum, rather than a point-in-time judgment.
In addition to the idiosyncratic ESG risks related to each specific debt issue or issuer, KBRA’s analysis of ESG Management typically includes a review of broadly relevant topics such as climate risk, cyber risk, and increasingly, the risks that the environmental, social, or governance policy preferences of key stakeholders (such as customers, regulators, employees, voters or investors) may impact an issuer’s operating, capital, and financial plans, or, its reputation which is increasingly important for access to capital markets.
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