Rating agencies arrive at last
With Standard & Poor’s now poised to follow Moody’s arrival this spring, the rating agencies are scrambling to carve out a space for themselves in a green bond market that is used to relying on other sources of independent opinion and verification, reports Julian Lewis.
“Going back some years, we made the decision to focus on ESG risks and how they link up with our credit research and analysis. Investors were becoming more interested in having rating agencies be more transparent and clear about how ESG is factored into our analysis of creditworthiness,” recalls Henry Shilling, senior vice-president, environmental, social and governance at Moody’s in New York.
While the agency believed that its analysts were taking ESG into account, this was “perhaps not transparent”, he concedes.
With the green bond market growing fast, it opted to develop what Shilling terms “a companion product offering” to its conventional ratings. Although Moody’s credit ratings cover over 90% of green bond outstandings, they treat the product no differently from any other fixed income instrument.
This led investors to ask Moody’s for more analysis. In January, it sought comment on a proposed methodology and modified it in the light of feedback. The initial draft would have produced a decent grade with only minimal green underlyings, some market sources charged.
The agency then launched its Green Bond Assessment (GBA) evaluation and research service at the end of March. The first GBA was awarded in in May. It has been followed by five more.
“This companion is more process-oriented. It is a bit of a departure,” comments Shilling, who stresses that GBAs are not credit ratings.
They are also always requested and paid for by issuers, unlike some traditional ratings. “We don’t do unsolicited assessments in this area where the level of disclosure is less than normal. It requires the co-operation and assistance of the issuer,” Shilling notes.
All the same, GBAs are available to issuers whose debt Moody’s does not rate. While its first five assessments were of rated issuers — Green Storm (a Dutch securitisation), the City of Gothenburg, Mexico City Airport, TenneT and Upper Mohawk Valley Regional Water — its most recent was of a new name to the agency (Hero Funding, a US securitization).
GBAs are graded on a five point scale from GB1 — “prospects for achieving stated environmental objectives are excellent” — to GB5 — “poor” prospects. The agency calculates the grade from its assessment of five weighted factors: organisation (15%); use of proceeds (40%); disclosure of use of proceeds (10%); management of proceeds (15%); and ongoing reporting and disclosure (20%).
All six GBAs to date have carried the top GB1 grade. But they incorporate the idea of a ‘refresh’. This is analogous to upgrades and downgrades of traditional ratings — except that it is based on Moody’s analysis of issuers’ periodic disclosures (usually annual or quarterly) of the underlying projects’ environmental impacts versus expectations. Although they are not monitored constantly like traditional ratings, “there is potential for assessments to move up or down the scale,” Shilling affirms.
As this report went to press in September, Standard & Poor’s was seeking comment on proposals for both a green bond evaluation tool and ESG assessments. It had set deadlines of mid-October for responses, with prototype launches to take place before the end of the year. The green bond product would include separate scores for transparency, governance and mitigation and/or adaptation, as well as a score based on a weighted combination of the category scores. The overall score would be on a five point scale (E1 to E5).
Despite the agencies’ relatively late arrival in the sector, green bond players applaud their moves.
“It is especially inspiring that we now have Moody’s and S&P, both major rating agencies, contributing to the evaluation of green bonds. It certainly indicates a level of credibility and significance that this asset class has arrived and is being taken seriously,” comments Ashley Schulten, head of climate solutions, fixed income at BlackRock in New York.
The arrival of “such important institutions illustrates that green bonds are becoming an integral part of the capital markets — they are not something you can ignore,” adds Lars Eibeholm, head of treasury at the Nordic Investment Bank in Helsinki.
“It is very significant to have Moody’s and S&P come in. It brings further legitimacy to the market,” agrees Nicholas Pfaff, senior director at the International Capital Markets Association and Secretary to the Green Bond Principles in London.
Not all see the need to pay up for GBAs, however. For example, Germany’s KfW judges that “acceptance of our green bonds wouldn’t be increased”, according to Doris Kramer, vice-president, investment strategies, sustainability in Frankfurt. KfW already uses Cicero to provide second opinions on its issues and has provided data for unsolicited ratings from Oekom.
As an investor, it would favour Moody’s analysis “going a bit deeper in assessment of projects”, Kramer says. “They aren’t there yet.”