The recent announcement by global credit rating agency, S&P Global Ratings, that it will stop providing numerical scores against ESG criteria for corporate borrowers has put credit ratings, credit rating agencies and ESG assessments in the spotlight.
In this article, we seek to explain what credit ratings and credit rating agencies are, the role they play on a capital markets transaction and how they assess a borrower's ESG exposure.
What is a credit rating?
A credit rating is an independent assessment of a borrower's ability to pay back a debt. It is based on an assessment undertaken by a credit rating agency and is designed to provide potential investors with an evaluation of a prospective borrower's creditworthiness and risk. They are assigned by a rating agency and use letter designations ranging from A (as a high credit rating) to C or D (as a low credit rating). They can be assigned to individual borrowers, but can also be assigned to financial instruments issued by those borrowers. Rating agencies stress the ratings are an independent opinion of the borrower and not a guarantee of total risk exposure.
What is a credit rating agency?
A credit rating agency is an independent company that analyses a borrower's creditworthiness and assigns them a credit rating. The three major credit rating agencies are S&P, Fitch and Moody's.
What role do credit ratings play on a transaction?
On a capital markets transaction, borrowers obtain a credit rating from a rating agency in order to showcase their credit profile to investors. This takes the form of a letter designation, giving the potential investor a snapshot insight into the creditworthiness of the borrower. The credit rating is obtained prior to the transaction and can change, depending on the borrower. On some capital markets transactions, rating changes can trigger coupon increases or decreases.
How do credit rating agencies assess a borrower's ESG exposure?
Some ratings agencies issue analysis of a borrower's environment, social and governance (or, ESG) exposure as part of its evaluation of the borrower and/or its financial instrument. They then ascribe a numerical value to the borrower based on that analysis. In assessing ESG risks, S&P Global Ratings had previously ascribed a numerical value as well as provided detailed written analysis of the ESG risks, but it has since taken the decision to remove the numerical score from their assessment. Borrowers looking to showcase their ESG credentials, or investors looking to invest in prospective borrowers, will need to scrutinise how the relevant rating has been arrived at as part of the transaction process.
From our experience, borrowers and investors are increasingly focussed on ESG metrics as part of their business strategies and this will no doubt intensify as markets continue to adapt to the UK's net zero drive. We will be pleased to address any questions borrowers or investors may have. Please do not hesitate to contact us if you have any questions or further enquiries.
