How Does ESG Alter Credit Risk? India Ratings Wants To Spot The Link

Starting the New Year's day, India Ratings and Research Pvt. will start integrating commentary on how certain environmental, social and governance issues impact the credit ratings of companies.

It announced the launch of ESG Relevance Disclosure, which would now be part of its rating action commentaries from Jan. 1. The move comes as ESG is increasingly becoming a defining factor for the flow of capital across the world.

"We are trying to see what is the intersection of the ESG risks with the credit risk over the rating horizon of five years," Rakesh Valecha, senior director and head of the core analytical group at India Ratings, told BloombergQuint. "Our aim is to see if there are any ESG factors that are, either on their own or in conjunction with other rating drivers, impacting credit ratings. And, if there are, to highlight (it) and bring forth in our disclosures.”

India Ratings' analysis will be drawn from 14 factors—five environmental, five social and four for governance—based on a framework devised by the Sustainability Accounting Standards Board. The credit rater will then classify these in three broad categories to show whether any of the factors are minimally, moderately or highly relevant to the credit rating decision.

How It Differs From ESG Ratings

India Ratings says it's different from scores measuring compliance of ESG-related criteria. "We are not making any moral judgements on any company. It's not up to us to say whether ESG practices of a company are good or bad."

Valecha explains that their commentary will provide the relevance of ESG factors to the credit rating. He gives an example:

"Take the coal industry. You would obviously classify it as one of the most polluting, and hence, that will negatively impact its ESG rating. But from a credit perspective, those risks may not play out in the next five years. The pace of transition from coal to renewable will remain an evolving process. So, it may not see its credit rating being negatively impacted, at least for now."

However, if local restrictions or social unrest cause a particular polluting unit to shut down in view of the larger impact to the society, then the credit rating may be impacted, he said.