From a credit perspective, it’s crucial to incorporate ESG factors into the analysis of credit risk—and to do so consistently across sectors and time. That’s why at CreditSights we have refined our process of including ESG issues.
Measures & Materiality
With so many factors that relate to E, S and G currently capturing the headlines, it is easy to lose sight of which ones are truly important when it comes to credit risk.
For us to include a measure within our analysis, it needs to have the capacity to materially affect credit risk (MACR). Therefore, even if a measure is often cited with reference to E, S, or G, it is excluded from our approach if it does not have the capacity to materially affect credit risk.
An existing controversy around an issue is not enough by itself to warrant inclusion as a measure. To be incorporated in our scoring process, the issue must present an actual credit risk with the potential to have a material impact.
Once we have determined the appropriate measures and peer group, we score the companies. First, we ensure that we are normalizing the data by an appropriate comparator. Second, we consider whether any two selected measures are in fact capturing the same underlying risk and therefore duplicative. The normalized measures are then converted into a 1 to 5 score (1 being the greatest risk, 5 the least) by considering them along a spectrum of risk:
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