Pushback against the use of environmental, social, and governance scores in public finance ratings is gaining steam in Republican-controlled states, where elected officials are targeting S&P Global Ratings, claiming it is politicizing the ratings process or even possibly acting illegally.
But demand for the information, particularly among younger investors, will likely ensure that ESG is not going away as a factor in credit evaluations.
“We know the ESG space is exploding and if you're a rating agency and you are concerned about your relevance to this new generation of investors who are getting into munis, you’ve got to have the ability to point to ESG considerations,” said Justin Marlowe, a research professor at the University of Chicago’s Harris School of Public Policy.
Social and governance factors in particular have always been a part of credit ratings; what’s new is the spotlight rating agencies are now shining on ESG, according to Marlowe.
“They are doing something very different by putting specific attention on ESG factors and leaving some ambiguity around how market participants ought to think about those factors and what they might mean for future ratings even if they’re not directly incorporated today,” he said.
Protests from the right are driven in part by the lack of clear definitions for ESG, said Jonathan Williams, chief economist at the American Legislative Exchange Council, an organization that pursues conservative economic policies at the state government level.
“In so many cases I think conservatives feel like ESG is being used as a political cudgel from the far-left progressive movement to go after states that otherwise take pride in becoming very fiscally well-run states like Utah and I think the Utah delegation was right to push back against this,” he added.
Utah officials
Idaho objected to S&P’s use of ESG scores and “any attempts at subjective quantification beyond the conservative and careful management of a state’s finances, repayment of debt, and a state’s ongoing creditworthiness.
“Idaho
In March, S&P assigned neutral ESG “indicators” to Idaho, noting they “have no material influence on our credit rating analysis” for the state.
The rating agency assigned moderately negative environmental indicators to Utah due largely to long-term water supply challenges and to West Virginia as the transition toward energy renewables was seen as further reducing mining employment in that state, which also got a negative indicator for population and demographic-related social factors.
In Louisiana, which received moderately negative environmental and social indicators, Republican state Treasurer John Schroder is also pushing back.
“Use of ESG indicators to determine creditworthiness undermines what should be an impartial credit rating system,” he said in a statement to The Bond Buyer. “It changes the trajectory of the ratings system from gauging the ability to pay debt service to forcing alignment with policy goals.”
Republican-controlled Oklahoma received a moderately negative environmental indicator related to oil and natural gas production and Andrew Messer, the state’s deputy treasurer for policy and debt management said while the new framework provides additional context, he doesn’t expect it to affect the state’s bond rating.
“S&P has for many years noted the economic concentration in the energy sector as a credit factor that has weighed on our rating,” he said in an email. “We will continue to monitor how the framework is applied and expect fair treatment from the agencies in evaluating relative risks associated with the state’s creditworthiness.” S&P rates Oklahoma AA with a stable outlook.
A S&P spokeswoman said the rating agency is not commenting on specific states. But in a reply to Utah’s protest, made available to The Bond Buyer by the state treasurer’s office, S&P made it clear it was not backing down.
“Our ESG credit indicators for Utah reflect those ESG credit factors that we consider material to our analysis of Utah’s creditworthiness,” S&P's public finance head Eden Perry said in
Perry said the rating agency reached out to every state prior to the March 31 publication of ESG indicators to answer questions and address feedback and that there was no response from Utah.
Oaks, who
“It does not answer the direct questions we posed to the credit rating firm nor adequately address the key arguments we made against the counterproductive, misleading, and possibly illegal focus on ESG factors as part of its credit ratings for states and state subdivisions,” he said.
As for the illegality concerns, which S&P denied, a spokesman for the Utah Attorney General’s Office said, without offering detail, a number of issues were being analyzed "for potential criminal violations.”
In a May 9 FAQ, S&P said market participants were increasingly seeking ESG-related data and that its ESG credit indicators cannot cause upgrades or downgrades.
It's ESG indicators don't track political divides.
In deep-blue, California, for example, the indicators were moderately negative across the board.
In Colorado, which received a moderately negative environmental indicator due to risks from wildfires and drought, state Treasurer Dave Young, a Democrat, said rating agencies have weighed many of these factors for years.
“The new methodology simply clarifies these specific areas by category, and gives recognition to the increasing interest and importance of this information to investors,” he said in a statement. “Colorado and the rest of the West, for example, face challenges related to wildfire and drought conditions. What’s of interest to investors, and ultimately, Coloradans, is what states are doing to mitigate areas of concern when and where they can.”
The debut last year of ESG-related scores from Moody’s Investors Service did not spark similar outcry.
Increasing investor requests for more insight and transparency into what ESG means for credit ratings led that rating agency to release issuer profile scores indicating the extent a state is exposed to credit-related ESG strengths or weaknesses, and credit impact scores on how much ESG factors affect a rating, according to Timothy Blake, a Moody’s managing director.
A request for comment process ahead of the scores’ release did not result in any significant changes to Moody’s proposal, he said, adding that an assigned public rating could continue even if an issuer has a problem with its ESG scores.
“From time to time we are asked not to rate the new sale or maybe we’re asked to withdraw a rating, but if we have sufficient information we continue to rate,” Blake said. “And if we continue to rate, we’ll continue to have the ESG scores as well for the rated issuers.”
Credit impact scores were neutral to low for Idaho, Louisiana, and West Virginia and positive for Utah.
Meanwhile, other rating agencies have publicly downplayed the impact of ESG on ratings.
A recent
“Fitch’s ESG relevance scores communicate how ESG factors affect an issuer’s credit rating, and do not provide commentary on the ESG merit of the issuer,” a spokesman said.
Kroll Bond Rating Agency called ESG scores “a disservice to market participants.”
“As a credit rating agency, we have judiciously avoided the inclusion of a distinct ESG scoring system into our credit rating methodologies and reports,” KBRA said in a report. “This approach is backed by extensive issuer and investor feedback which found the merging of ESG scores — often including factors that do not impact the credit analysis — is confusing.”
Dan Solender, director of tax-free fixed income at investment management firm Lord Abbett, said it is useful for rating agencies to develop opinions on ESG issues as traditional and possible new muni investors begin to view ESG analysis as important.
“Over time, issuers who have good ESG ratings are likely to benefit from a larger base of investors being interested in buying their bonds and possibly lower borrowing rates if they are reviewed based upon ESG criteria,” he said.
