Economic, social and governance issues – or ESG as they have become known as – have risen up the corporate agenda in recent years, fueled by the pressing climate crisis and a number of social shifts such as the rise of the #MeToo movement and a renewed focus on racial and other forms of inequality.
The moral argument behind this focus is clear, but what do these issues mean for business resilience and sustainability?
Arguably, the Covid-19 pandemic has made business resilience more important than ever, and Kroll Bond Rating Agency (KBRA) head of ESG Pat Welch says ESG is becoming a fundamental consideration when it comes to assessing business resilience.
“ESG is primarily an investing concept, and that is becoming an increasingly important way that investors define their investing priorities,” he says. “It’s increasingly impacting how capital is mobilizing in the capital markets, and that will also translate into how capital is mobilized outside of the capital markets.
“And how capital gets mobilized, is very connected to your own business resilience, and your own long-term performance,” Welch says.
Insurance has Opportunities to Lead
Despite the importance of these issues to resiliency, KBRA president and CEO Jim Nadler is surprised at the differing pace of change across different sectors of the industry, with global reinsurers appearing to be more prominent on ESG issues.
“There is a fantastic opportunity for the P&C market to be leading the charge here, because it is the most exposed industry to climate change risks,” he says. “Not only do you have hurricane risk increasing in the Caribbean and the Atlantic, but you also have the increasing risk from drought, and wildfires seem to be out of control.
“So I’m surprised the P&C market is not leading more in this space, but one thing we are seeing is an increased appetite in the reinsurance market to look at these risks, and they are investing money into the market. So that’s encouraging.”
Another cause for optimism is an increasing level of interest on ESG matters amongst stakeholders, and Nadler says this has increased the pressure on boards to do more about these issues.
“We are hearing from companies across the board that they are much more interested in what their employees, customers and investors think on a variety of issues, whether it be diversity, climate change, or a whole raft of other ESG issues,” he says. “So there is definitely a growing movement amongst stakeholders to ask more questions and find out more about these issues.
Nadler says that stakeholders have also become a lot more vocal than they were a few years ago.
This means that issues such as diversity or climate change are much more at the forefront of business leaders’ minds, driven by the increase in access to social media and a seemingly constant stream of negative headlines and organizations consequently wary of being caught up in the next corporate scandal.
How to Assess ESG
When it comes to assessing ESG and its importance to resilience, KBRA is taking a different approach to others in the market.
Stakeholder risk is a dynamic risk – tomorrow, we could all wake up and hear about how investors or customers have set in motion a powerful boycott against a company over some particular issue.
Nadler says that in addition to looking for how ESG issues affect the credit strength of an organization, stakeholders are also looking for additional information about how these issues might affect businesses in other ways.
Nadler says that ratings agencies should be the “perfect vehicle for disclosure” of such information.
“The information we provide as part of our rating doesn’t just look at how these issues are affecting the credit strength of an organization today, it also looks at the potential impact of these factors further down the road,” he says. “These are the kind of things that investors need to consider, as it might not affect their investment today, but it could seriously affect the liquidity of their bond in three- or four-years’ time.”
This means that KBRA does not assign an ESG score to the companies they rate – Welch says the issues are far too complex for such a simplistic approach – but instead provides a narrative that explains the ESG risks surrounding an organization, including how those risks are being managed and how they could affect the company in the future.
This is consistent with how the ratings agencies treats other qualitative risk factors, such as the management team in charge of an insurance company, or the overall business strategy.
And Welch says that this information is vital for investors and businesses alike when it comes to ESG, as it gives deeper insights into an entity’s unique risks, with stakeholder risks becoming an increasingly important element.
“Stakeholder risk is a dynamic risk – tomorrow, we could all wake up and hear about how investors or customers have set in motion a powerful boycott against a company over some particular issue,” he says. “So trying to understand stakeholder risk as it stands today, and also what it might look like in the future, is of fundamental importance.
“Businesses need to know who their stakeholders are, what they are concerned about, and how to address the various communities of stakeholders they are presented with. Those are all things that very actively come into the intersection with credit risk, and are vital to our credit analysis and our ratings.”
“Companies are engaging with us more actively on these issues,” he says optimistically.
And KBRA’s work in this space has meant that Lloyd’s of London recently asked the agency to provide it with a rating alongside the ratings it already holds from other agencies.
A recent report from the insurance market revealed how it was approaching ESG issues, including a number of targets and a commitment to increasing the sustainability and transparency of insurance business conducted through Lloyd’s.
This shows the importance that Lloyd’s and the wider insurance industry is now placing on ESG, and this is only going to increase as these issues remain firmly in the spotlight, both from a social and a financial standpoint.
