Corporate Social Performance and Credit Risk

The financial sector can play a role in aligning private sector incentives with sustainable development, without incurring additional financial risk or sacrificing returns, but the CSP-credit risk relationship is dependent on country sustainability.

Introduction

Financial markets play an important role in the allocation of capital by attracting funds from investors and channelling them to corporations. In particular, the magnitude and direction of credit is strongly influenced by credit rating agencies (CRAs), which is dominated by three market players: S&P (previously Standard & Poor’s), Moody’s and Fitch. However, the global financial crisis (GFC) of 2008 provides recent evidence that ratings may be affected by systematic errors or biases.

In 2011, the US Financial Crisis Inquiry Commission, in its 2011 report, wrote that “the three credit rating agencies were key enablers of the financial meltdown”. In 2013, the US Department of Justice (DoJ) sued S&P for fraudulently inflating ratings on mortgagebacked instruments prior to the financial crisis.The lawsuits were resolved in 2015 with S&P agreeing to pay a US$1.5 billion (RM6.5 billion) settlement fee, which exceeds the profits earned by the company for rating mortgage-backed securities from 2002 to 2007.

More recently, regulatory pressures on CRAs have been building up in Europe, particularly in relation to sustainable finance. In 2018, the EU acknowledged that CRAs are systemically important institutions and their risk assessment methods influence the sustainability and stability of the financial system. While the consideration of non-financial or qualitative information, such as environmental, social and governance (ESG) criteria, is not new to credit risk analysis, the systematic analysis of ESG within the framework is. In May 2016, the UN-supported Principles for Responsible Investment (PRI) launched the Statement on ESG in Credit Risk and Ratings for investors and CRAs to publicly state their recognition of the value of considering ESG factors transparently and systematically in credit risk analysis.