The new green screen for investors

Welcome to POLITICO’s new Sustainable Finance Spotlight — an extension of the Global Translations newsletter. Each week we track major issues facing the globe. Sign up here.
Credit ratings and the data behind them are big business, and the effects are felt in millions of households, via mortgage and credit card decisions, at companies looking to finance expansion, and government offices undertaking big projects.
Increasingly, banks and credit rating agencies are now considering long-term factors based on a company’s resilience against major challenges like climate change, and now, pandemics, when making lending decisions and publishing investment guidance — shifting the way people and organizations can access capital. Over 20 credit rating agencies have signed up to the United Nations Principles for Responsible Investment.
S&P this month updated their Environmental, Social, And Governance Evaluation Analytical Approach to address a “growing appetite among investors,” said Hans Wright, S&P Global Ratings head of analytical innovation, to “go beyond a creditworthiness lens” when making investment decisions. Today’s investors want “to know the impact on the big issues for us as a human race,” he said.
For example, S&P Global Ratings said Monday that social bonds — such as investments in food security and increasing access to education and health care — will be the fastest-growing segment of the sustainable debt market in 2020.
ESG evaluation focuses on an organization’s “capacity to operate successfully in the future,” and describes what is driving a company’s ability to navigate disruption, Wright said. Companies with high scores “are more likely to be able to navigate and manage through disruptions” and seize new opportunities and are “less prone to controversies,” he said. “We’ve ranked sectors on their environmental exposure, countries on their government standards,” and so on, Wright added.
Over his 20 years at S&P, Wright has witnessed the explosion of all things ESG — analysis, labels, financial products and debate. While the company could have tried to build ESG factors into its existing credit rating process, the company decided to create new measures, instead. “We’ve been doing ESG analysis forever,” but no one called it that until recently, Wright said. And he reasons, “if it ain’t broke, don’t fix it.”
Wright said that bringing ESG evaluation to all 7,000 companies S&P analyzes will be a gradual process. “We’re conducting ESG evaluations only on request: We’ve done 40 so far,” he said.
S&P faces one problem in refining its ESG information that is familiar to all involved in sustainable finance: data that Wright called “very immature.” That, in turn, means S&P’s 1,400 analysts and sector experts play a big role in cross-checking data, speaking to the companies being evaluated, and rounding out the product.
Take the example of electricity sector companies: Evaluating the electricity generator and the network are two different processes, and the energy source can also have a massive impact on the final evaluation “before we even start thinking about the (company’s) performance,” Wright said. “You can be the best of the fossil fuel generators, but that would still put you pretty low (overall). The worst solar generator, meanwhile, “could be better than the best fossil fuel.”
In the mortgage market, the factors affecting whether applicants are approved are also expanding well beyond personal creditworthiness and into territory like whether the property might flood decades into the future due to climate change.
The government’s biggest housing subsidies — mortgage guarantees and flood insurance — are on course to hit taxpayers and the housing market as the effects of climate change worsen. Recent POLITICO analysis found that a series of disasters in a single region could trigger a full-blown housing crash, while a National Bureau of Economic Research working paper concluded in February that homes in flood plains are overvalued by $34 billion, because home buyers don’t fully price in the high risk of climate-related disasters.
Freddie Mac Chief Economist Sean Becketti warned about this issue in 2016: “Some of the varied impacts of climate change — rising sea levels, changing rainfall and flooding patterns, increasing temperatures — may not be insurable,” Becketti wrote. The financial effects for home buyers are starting to include demands for bigger down payments — as much as 40 percent of the purchase price — in flood-affected areas.
SUSTAINABLE FINANCE SNAPSHOTS
ESG funds keep outperforming: The Institute of International Finance concluded in a new report that 85 percent of ESG equity indices and 80 percent of ESG fixed-income indices outperformed their non-ESG peers in 2020. According to IIF, the ESG fund universe has tripled to over $1 trillion since 2015, but that is still only 1 in every 40 dollars invested in stock funds. The majority of ESG investments are based in Europe. Full report here.
Meet patient capital and patient debt: “Workers around the world have about $40 trillion invested in the global economy,” via their pensions, International Trade Union Confederation General Secretary Sharan Burrow told POLITICO. “We’ve preached patient capital,” in relation to pension investments, she said. “Don't use the speculative route, use a route that builds things, that builds economies, that build sustainable companies, and good jobs.”
“We also now need patient debt,” Burrow continued, so that governments can pay back Covid-19 debts in ways that don’t undercut social safety nets and public goods.