Monday, 24 July 2017

Article Preview: Sustainable Finance: Why the Formal Introduction of Credit Rating Agencies Should Serve as a Warning – Financial Regulation International

Today’s post previews a forthcoming article by this author entitled ‘Sustainable Finance: Why the Formal Introduction of Credit Rating Agencies Should Serve as a Warning’, to be published in Financial Regulation International. A pre-published version can be found here and the purpose of this post is to introduce the article and some of the key concepts flagged within it. With the issue of sustainable finance coming to the fore in the public and investing consciousness, the increase in information asymmetry is sure to follow and, when it does, the door opens for the rating agencies to position themselves within the process. We have already discussed the agencies’ entrance into this arena before here in Financial Regulation Matters, however this need for the agencies has traditionally resulted in exploitation so, in that regard, the article looks at the possibility of this phenomenon repeating itself in this specific arena.

The article begins by discussing how ‘sustainable finance’ as an ideal is growing ever more popular, particularly since the Financial Crisis. Sustainable finance, which is very different from Ethical Investing – which is concerned with investing in line with a certain set of beliefs of wishes – is the process of investing for profit, but with an increased consciousness regarding the impact of the investment. With regards to the capital markets, which is the focus of the article, there is a growing need for issuers of debt to demonstrate to potential investors that their companies operate in a certain manner, particularly with regards to their adoption of the principles that can be understood in terms of ESG, or ‘Environmental, Social, and Governance’ concerns. These ESG concerns have been the focus recently of large institutional investors like the Church Commissioner’s Group who have been putting large companies like Shell under immense pressure to prove that they are incorporating measures to ensure their commitment to ESG principles. Furthermore, there is a push by the UN to incorporate certain Principles with regards to responsible investing, which is why the Principles for Responsible Investing (PRI) has been established and why the article has decided to focus upon one its recent endeavours: to bring credit rating agencies into the fold.

The leading agencies have recently become signatories to the PRI and have pledged to incorporate ESG principles into their methodologies even more than they have done before which, at first glance, looks like progress. The PRI were critical of the agencies beforehand, mostly in relation to the fact that rating methodologies have tended to overlook ESG criteria – particularly the Social and Environmental criteria – for a host of reasons. Whilst there is an argument to be made that investors are primarily concerned with Governance when looking at ESG, especially when they are concerned with the creditworthiness of the issuer, it is also the case that the refusal to appropriate adequate resources to the rating of ESG criteria also constrains the possibility of investors engaging with the other elements of ESG. The agencies have therefore pledged to incorporate ESG into their methodology more but, in keeping with the tradition of the credit rating industry, they are adamant that they will do so on their own terms, with Moody’s clarifying that its understanding of ESG and the PRI’s understanding of ESG will likely differ. Yet, for the article, there is cause for concern.


The concern for the article emanates from the inclusion of an industry that has proven it will sell its wares to the highest bidder. The real need for sustainable investment means that the more attention the sector receives, the more pressure will be on issuers to provide evidence of complying with ESG concerns. This dynamic places the rating agencies at the centre of a process whereby it will be in the interest of issuing companies who do not meet the standard to incentivise the agencies to rubber-stamp their issuances anyway – the exact same process as the Financial Crisis. As we know, the agencies chose money over standards, so we have little reason to believe that just ten years on anything has changed, particularly when we consider that the agencies have continued to transgress. Therefore, whilst it is vital that sustainable finance grows as an ideal and, eventually, becomes a norm, it is unlikely that the credit rating agencies will contribute positively to that aim. Unfortunately, the emphasis is yet again on investors to both demand that issuing companies operate in a sustainable manner and that those who signify this information to the disseminated investing public do so in an absolutely transparent fashion – we must know how an agency has deemed an issuer has considered environmental, social, and governance concerns or else there is likely to be rush of investment into a marketplace that is not what it seems.

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