It is more difficult to define environmentally harmful activities – or ‘brown’ practices – in business than it is define ‘green’ activities, according to a note from Fitch Ratings.
Reflecting on the first three months of the year in its note ESG Credit Quarterly 1Q20 – Defining “Brown” May Shape Policy, the credit rating agency said a key development for the period was the European Union’s publication of its final report on the taxonomy for sustainable activities. This details a list of ‘green’ activities it deemed supported the EU’s environmental policies and the green-finance system in order to transition to a climate-neutral economy by 2050.
“Fitch expects it will be even more difficult to find a global consensus on brown activities, given the starker economic trade-offs for more carbon-intensive economies,” it said.
It also highlighted that defining brown activities could have greater implications than defining green activities, as it is likely that “labelled activities will be the target of disincentive policies such as prudential regulation”.
“The brown taxonomy could also inform how banks and asset managers screen for other fossil fuels or environmentally harmful activities,” it added.
“ESG considerations have also increasingly affected lending and investment decisions, in turn affecting corporates’ ability to raise finance. Negative screening is the most commonly applied ESG strategy, and many asset managers apply exclusionary criteria across actively managed assets whether or not they are labelled as ESG.
“Sectors facing hard exclusion criteria are limited to the most severe social issues, but such criteria are increasingly applied to activities deemed environmentally harmful, such as thermal coal.”
ESG scoring of credit
The note also highlighted that in the year since Fitch begun scoring credit, 2.1% of corporates and 1.7% of financial institutions issuers experienced an increase in ESG.RS (its scoring system). to ‘4’ and ‘5’, from ‘1’ to ‘3’, indicating that ESG factors now affect the credit-rating decision, when they hadn’t before.
Governance factors were increased the most frequently, it said, while ecological-impact scores increased due to operation incidents such as tailing-dam issues for miners, and “exposure to social impacts” scores increased due to operational disruption to production in conflict zones.
“While there has been investment in renewable-energy generation across regions, the reduction in fossil-fuel generation has varied. Countries that have adopted pledges for net-zero carbon-emission by 2050 or earlier are generally the least carbon-intensive, while those that have not are both the most carbon intensive and most populous,” the Fitch note added.