Lower Credit Ratings for Firms with Poor ESG Ratings

Poor environmental ratings and higher carbon footprints are associated with lower corporate bond credit ratings and higher yield spreads, particularly for firms located in states with stricter environmental regulations, according to  Lee Seltzer of the New York Federal Reserve Bank, Laura Starks of the University of Texas at Austin, and Qifei Zhu of Nanyang Technological University.

This research – the latest rebuttal to climate change dis-avowers – came AutoInformed’s way from the Hutchins Center on Fiscal and Monetary Policy* at the Brookings Institute. So-called Environmental, social, and governance ethics, aka ESG, are becoming an increasing factor in a company’s ratings because they reflect its ability to survive in AutoInformed’s view – if the earth survives.**

“Using the 2015 Paris Agreement as a shock to investors’ expectations of future environmental regulations, the authors find that firms with poor environmental profiles (constructed using ESG ratings and carbon emissions data) saw their credit ratings fall and yield spreads rise relative to greener companies after the agreement, especially in environmentally stringent states—suggesting that both credit rating analysts and bond investors reacted to potential tightening of environmental regulations in the future,” Hutchins summarized.

The composition of bondholders also changed post Paris 2015. Insurance companies, which tend to have longer investment horizons, decreased their holdings of the less green companies while shorter-term mutual funds did not. These findings reinforce the idea that regulatory risk is “a major channel through which climate and other types of environmental risks get embedded in security prices,” the authors say.

*The mission of the Hutchins Center on Fiscal and Monetary Policy is to improve the quality and efficacy of fiscal and monetary policies and public understanding of them. It provides independent, non-partisan analysis and draws on the expertise of Brookings Institution scholars and of experts in government, academia, think tanks and business, as well as the guidance of its Advisory Council. By commissioning research, convening private and public events and harnessing the power of the Internet, it seeks to generate new thinking, promote constructive criticism and provide a forum for reasoned debate. The Center was founded with a gift from the Hutchins Family Foundation.

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