Establishing credit-relevanceNew market analysis from Fitch Ratings considers the factors on tax and revenue ratings. Access the full report here.
Fitch Ratings-New York-10 May 2021: Fitch Ratings provides insight into the credit relevance and materiality of environmental, social and governance (ESG) factors for each US Public Finance sector, highlighting the rating effect of ESG factors in case studies, in its new report Where ESG Matters for U.S. Public Finance. Fitch uses ESG Relevance Scores (ESG.RS) to communicate the effect of these factors on both US tax-supported and revenue-supported issuer ratings.
Governance is the most influential ESG factor for US Public Finance (USPF) as a whole, given the importance of management strategy, internal controls, quality of service provision and financial transparency to every sector. Cybersecurity risks, a governance and social consideration, continue to raise significant governance and social issues that may pose harm to consumers or residents and reveal management weakness, potentially negatively affecting ratings. Governance factors are expected to remain highly relevant to ratings beyond issuer navigation of the pandemic recovery.
Environmental Factors Gaining
Environmental factors have gained more importance in USPF rating decisions since the ESG.RS were introduced in May 2019. Recent events bring this issue into sharp focus, resulting in elevated ESG.RS for Exposure to Environmental Impacts for 19 public power issuers following severe weather events in Texas in February 2021 and for some military housing projects due to moisture remediation issues. Environmental factors continue to have a more modest influence in the tax-supported portfolio, with elevated scores largely recorded in Biodiversity and Natural Resource Management, as well as Natural Disasters and Climate Change.
Social factors such as Labor Relations, Customer Access and Customer Welfare have negative rating effects for a number of USPF sectors and credits. Conversely, social factors have an overwhelmingly positive influence on community development and social lending credits.
ESG.RS incorporate 15 general ESG issues for tax-supported issuers and 14 general ESG issues for revenue issuers, and are expressed on a ‘1’ to ‘5’ scale, with ‘1’ indicating irrelevance and ‘5’ being highly relevant for the rating. An ESG.RS of ‘4’ or ‘5’ can be positive or negative to a rating decision, although the majority of assigned scores reflect a negative impact.
Excerpts From The Study: Where ESG Matters For U.S. Public Finance Ratings
- Governance Relevance Is Still Key in USPF
Governance is the single most important ESG factor in USPF given the impact of management strategy, internal controls, quality of service provision and financial performance in every sector. Successful implementation of management policies, without undo interference from appointed boards and/or elected officials, remains critical to strong performance. Governance factors are expected to remain highly relevant to ratings moving forward. A growing concern, cyber breaches present both social and governance risks. Specifically, cyber risk is evaluated in terms of safety and security, as well as in terms of management effectiveness.
- Environmental Factors Gain Importance
Environmental factors have gained more importance in USPF rating decisions since the ESG.RS were initially released in May 2019-boosted by the severe weather events in Texas in February 2021, that resulted in 19 public power issuers’ ESG.RS for Exposure to Environmental Impacts moving to ‘4’ from ‘3’. Noted environmental impacts have also grown due to the addition of ESG.RS for community development and social lending (CDSL) issuers in January 2021 and the recognition of environmental issues in some housing projects. Environmental factors continue to have a more modest influence in the tax-supported portfolio with elevated scores largely recorded in Biodiversity and Natural Resource Management as well as Natural Disasters and Climate Change.
- Social Considerations
Notable in CDSLThe addition of ESG.RS for USPF CDSL issuers also increased the recognition of social factors in rating decisions although, due to the nature of many CDSL programs, rating impact in the sector is overwhelmingly positive. Conversely, elevated ESG.RS across the remainder of the portfolio reflect rating impacts from Labor Relations, Customer Access and Customer Welfare concerns.