S&P Global Ratings recently released a report that says environmental, social and governance (ESG) factors played a part in credit ratings of its U.S. public finance (USPF) entities. From Jan. 1, 2017, to Dec. 31, 2018, S&P Global Ratings found that ESG factors were primary credit drivers in 34% of the total 3,315 USPF rating actions.
Further, the report states, “Governance and management issues, at 67%, were the most likely factor to lead to a rating action across sectors, although some sectors (such as public power, utilities, and transportation) were more sensitive to environmental issues as well." Social issues were a factor in about 28% of the rating actions the rating agency took. The report authors noted they believe the overall distribution could change as transparency and disclosure practices of rated issuers improve.
The report notes that irrespective of region or sector, the absence of a cited ESG factor in a rating action does not necessarily imply the absence of ESG considerations in the ratings. The authors write:
For example, environmental factors play the largest part in public power, water and sewer utilities, and transportation ratings, while they have not for charter schools. Extreme weather events did have a large effect on the underlying finances or economy of several issuers, but other mitigating factors often counterbalanced the negative credit impact of the extreme weather event, leaving most issue ratings unaffected. Likewise, social factors were the most prevalent for higher education and charter school ratings, while they did not lead to any rating actions for the state sector during our two-year look-back period. Ultimately, the degree of environmental, social, or governance factor impact to rating actions varies across sectors, despite being a meaningful component of every public finance issuer's overall creditworthiness and holistically considered in our criteria.
In regard to ESG-related public power rating actions, S&P Global Ratings found that because fossil fuels are a principal input for electric utilities, environmental factors play a key role in S&P's analysis of public power utilities. The focus of legislators, regulators and the public on climate change contributes to initiatives for controlling power plant greenhouse gas emissions, utilities' use of bodies of water to cool power plants, and their disposal of the byproducts of producing electricity with coal and nuclear fuel.
The authors write:
Governance considerations are also important factors in our assessments of electric utilities. The evolving regulatory and legislative environmental frameworks for electric utilities task management teams with the need to develop strategic solutions that enable utilities to conform to regulatory mandates while serving customers with economical and reliable power. Cybersecurity risks also represent important governance issues for utility management.
Nuclear construction projects in Georgia and South Carolina provide an appropriate example of the influence of governance on electric utility ratings. The projects' significant delays and cost overruns underscore project stewardship issues. The report notes that the resulting political fallout and litigation among the project participants that challenge cost responsibility and the owners' right to cost recovery are also important governance considerations. In addition, cost recovery issues point to the social element of our ESG analyses, as do the effects of the projects' costs on the affordability of consumers' retail electric rates.
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