Transparency is crucial in assessing environmental, social and governance (ESG) impacts. Rahul Ghosh, managing director and global head of sustainable finance at Moody's Ratings, tells Environmental Finance why.

Environmental Finance (EF): Why is transparency important for sustainable finance?

Rahul Ghosh (RG): Climate and other ESG factors are often complex, multifaceted and interwoven, and therefore difficult to analyse. Investors are not just looking for transparency in terms of the information provided by companies, but also how resulting risks and opportunities translate into credit outcomes. As a credit ratings agency, it is really important for us to be clear in our approach and disclosure on how we see these issues influencing credit quality and over what timeframe.

We are also seeing increasing scrutiny of companies' sustainability and decarbonisation strategies. For those that are perceived as taking too little action to address material exposures or, at the other end of the spectrum, those that are seen as overstate their sustainability credentials, this could raise reputational risks.

So, transparency efforts by companies will help mitigate potential risks, as investor and regulatory focus intensifies in this area.

EF: How is Moody's Ratings promoting transparency in the industry?

RG: We've expanded our toolkit to provide extensive transparency on our approach to incorporating material ESG considerations into credit analysis.

For example, we have published an ESG general principles methodology that articulates our global approach to capturing ESG considerations in our credit ratings. This is publicly available.

We've also rolled out a suite of ESG credit scores, known as credit impact scores and issuer profile scores, across all the companies we rate. This covers sovereigns, regional and local governments, non-financial companies and financial institutions – so almost 12,000 entities that Moody's rates.

The issuer profile scores (IPS) provide an opinion on the level of credit exposure that an issuer, or transaction, faces from a range of ESG considerations. The credit impact score communicates the overall impact of these considerations on the credit rating of the issuer, or the transaction.

By providing this level of transparency, we can clearly demonstrate how ESG issues are translating into credit outcomes.

Moreover, we have launched a proprietary ESG credit platform for market practitioners that provides data, metrics, insights and tools to help investors measure and benchmark ESG exposure and risk within their credit portfolios.

EF: How material is the impact of ESG on global credit quality?

RG: As we have rolled out scores across our universe, we can clearly show the impact that ESG is having across global credit. Our analysis shows that ESG considerations have a material impact on the credit strength and ratings for almost one-fifth of the rated entities for which we've assigned a score, meaning the impact of ESG on credit strength is either discernible or pronounced, resulting a lower rating.

For a small part of our portfolio, about 3%, the credit impact is actually positive because of the benefits of exposure to ESG considerations, driving a higher rating overall. And for 26% of our portfolio, ESG factors are currently having a limited impact on the credit rating, but there is potential for greater adverse impact over time if these exposures are not carefully managed.

When we dive into the data, we find that the ability of an issuer to repay its debt in full and on time is closely tied to strong governance. Effective risk management, in turn, can mitigate exposures to environmental and social risks.

As such, we find a pretty strong correlation between governance and default risk. For a recent report, we looked at a sample of around 1,000 private sector entities for which we have ESG scores. And we found that of those that defaulted, more than 55% had been assessed as having 'a very high' credit exposure to governance risks and 35% had 'a high' exposure to governance risks.

EF: How has Moody's Ratings enhanced its sustainable finance solutions and services over the past year?

RG: We are broadening our sustainable finance offerings to provide high quality insight to support market practitioners.

For instance, we are continuing to build up our second-party opinion (SPO) business globally, on the back of rising market demand for sustainable debt across regions.

Since introducing a second-party opinion service within the rating agency less than two years ago, we've assigned almost 210 SPOs to entities spanning over 40 countries worldwide.

By creating a granular approach to scoring, we allow investors to dive into the quality of sustainable debt structures across regions and sectors.

For example, we have found that around 89% of all "use-of-proceeds" structures receive one of our highest sustainability quality scores – SQS1 (excellent) and SQS2 (very good). For sustainability linked structures, this share falls to 57%, reflecting an earlier level of development and mixed practices on target setting.

We've also introduced a new offering called a net zero assessment (NZA), which assesses the strength of a company's greenhouse gas reduction plans. Most market analytics focus on the ambition of targets, which we also do, but our assessment also places an emphasis on the soundness of implementation plans; or, in other words, what is the likelihood of an organisation actually meeting its goals. We do this by engaging with companies on their strategic plans.

This is critical for investors and other stakeholders that are looking to better understand which companies are likely to adapt or even thrive in a low-carbon future.

For more information, see www,moodys.com