KBRAs ESG Philosophy in Credit Ratings

KBRA focuses on environmental, social, and governance (ESG) factors that affect or have the potential to affect creditworthiness and the risk of default.

KBRA firmly believes that ESG factors require nuanced analysis to determine and understand financial materiality. We focus on ESG issues strictly in the context of how these factors are currently affecting the risk of default or how they may affect the risk of default over the longer term. We believe our value-add to the market is to comment on how ESG affects credit risk and that subjectivity around ESG impact should be left to the investor, not our credit rating analysts.

View ESG Methodology

CFG Credit Ratings

In rating corporates, financial institutions, and governments (CFG), KBRA considers an issuer’s active management of ESG issues, including its strategy for mitigating or capitalizing on ESG risks and opportunities. An evaluation of ESG management provides KBRA with insight into an issuer’s ability to adapt and plan for ongoing risks and opportunities, and how such activity may contribute to sustainable operating income well into the future. Over the medium-term, issuers across sectors will need to prioritize ESG risk management and disclosure as policymakers across the globe enact and expand ESG-focused regulation. Across CFG, KBRA has identified three ESG factors that intersect with credit for most issuers. Importantly, KBRA analyzes many other sector- and issuer- specific ESG issues but our analysis is often anchored around:

Climate

Climate Change (Focus on GHG Emissions) — As the effects of climate change evolve and become more severe, issuers are increasingly facing an emerging array of environmental challenges and potential opportunities. Physical climate risk, such as wildfires or flooding, and climate transition risk, which includes an entity’s GHG footprint, exposure to potential regulatory changes, and shifts in supply and demand, have the potential to affect financial assets, operations, and capital planning.

Stakeholder

Stakeholder Preferences — The effects of stakeholder preferences on ESG issues can affect the demand for an issuer’s product and services, the strength of its global reputation and branding, its relationship with employees, consumers, regulators, and lawmakers, and, importantly, its cost of and access to capital.

Cyber

Cybersecurity — As issuers continue to become more reliant on technology, cybersecurity planning and information management are necessary for most issuers. Regardless of size and industry, entities are at risk of cyberattacks. The losses incurred after a cyberattack are not only monetary—sensitive data and the entity’s reputation can also be compromised.

Structured Finance Credit Ratings

In structured finance transactions, and in some other related sectors, the ability to influence or mitigate ESG risks and opportunities through active management is limited because the underlying collateral, which may include loans, receivables, or other assets, are generally originated prior to securitization and securitized vehicles typically have finite lives. Given the wide array of assets and transaction structures within structured finance, the ESG factors that KBRA considers to be most relevant will vary depending on the underlying collateral of the loans being securitized, including:

Environment

Environmental factors that have the potential to affect an asset’s long-term value. Risks such as environmental contamination and non-compliance with environmental regulations can impair the value of the underlying securitization collateral. Additionally, the geographic profile of the  collateral pool is an important consideration for many structured finance asset classes, as certain geographic areas may be more vulnerable to natural disasters and the effects of climate change.

Social

Demographic trends drive the overall direction of the economy, which in turn influences the economy’s growth rate, consumption, and the demand for and performance of financial assets. These trends are primarily driven by population growth, demographic change, employment levels, changes in regulation, consumer behavior, and other secular trends. Additionally, socio-political risks are often a result of the confluence of social, political, and economic factors, and can manifest themselves in various forms. KBRA considers these factors in our analysis in totality, to the extent relevant.

Governance

The importance of governance factors in structured finance transactions varies based on the level of exposure the collateral pool has to the business risks of the sponsor, servicer, originator, or other key transaction parties. KBRA’s analysis generally includes a review of these entities depending on their importance to the transaction. Transaction structure and enforcement mechanisms, as well as governance provisions, are also important governance factors and are considered by KBRA in its analysis