This Kroll Bond Rating Agency (KBRA) report is a follow-up to a recent publication on how environmental, social, and governance (ESG) factors are considered in KBRA’s credit rating process across corporate, financial, and government (CFG) ratings. While our previous publication provided a broad overview of KBRA’s ESG integration process, this report serves to detail the credit-relevant ESG factors that may be evaluated when rating midstream energy companies.
As stated in our Credit Ratings Deserve ESG Risk Analysis, Not ESG Scores report, 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 believe this process contributes to a goal of improving meaningful disclosure of ESG issues that are impactful to credit.
KBRA uses a two-step process to identify credit-relevant ESG considerations. First, KBRA identifies and evaluates ESG factors that have a direct impact on the given transaction. KBRA defines direct impact as those factors that have a clear, tangible effect on credit, are typically quantifiable, and the assessment of which is generally rooted in existing methodologies. The second step is to evaluate an issuer’s strategy for identifying and mitigating ESG risks, as well as planning for opportunities. KBRA also reviews the affordability of an issuer’s management plan to address ESG risks and opportunities and whether it is achievable at the given rating level. Assessing management performance and capability has long held a prominent role in many of KBRA’s rating methodologies, meaning it is a natural extension to integrate certain ESG issues into the analysis of management teams. KBRA’s management review also includes an evaluation of an issuer’s exposure to changes in stakeholder preferences and how that may influence its reputation and creditworthiness.
Understanding stakeholder preferences and potential changes in demand is also a key feature of KBRA’s analysis of ESG issues. As ESG gains momentum and public sentiment continues to shift on issues like climate change and racial justice, it is crucial for an entity’s management team to understand their own reputational risk and exposure to changes in stakeholder preferences. During our analysis of stakeholder preferences, KBRA assesses whether constituents’ policy preferences on environmental, social, or governance issues present risks or opportunities for an entity and how the entity is managing (or utilizing) that risk. Stakeholders in the midstream energy space refer to regulators, investors, employees, customers, communities in which the company operates, or other relevant constituent groups.
Though KBRA evaluates the management of ESG issues, we do not make value-based, subjective judgments around ESG impact as this is inconsistent with objective credit analysis. Instead, we seek to illuminate, through our rating reports, how ESG factors may drive changes in the credit profile of the entity under consideration. As the relevance of ESG factors continue to evolve, KBRA’s analytical process aims to be bespoke and dynamic, capturing all the credit-related factors that may affect the risk of default for a given transaction.
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