The increasing prominence of social issues and the evolving preferences of investors are having an impact on the creditworthiness of some issuers.
“The exposure issuers have on shifting consumer preferences or social pressures and resistance can manifest as a credit risk in certain situations,” said Marina Petroleka, global head of ESG research at Sustainable Fitch.
This is identified in the latest report in Fitch’s ‘ESG in Credit’ series, capturing such credit issues arising from shifting consumer preferences driven by a desire to avoid harm or do good.
Assessing ESG exposure
While views are largely outside issuers’ direct control and might be highly dynamic over time, they can affect demand for products and services, impair operations and alter market shares, said the research.
For example, a greater emphasis on health and wellbeing, increasing rejection of products tested on animals or products containing raw materials associated with harmful social impacts, and alignment, or a lack of, with political parties and ideologies, can all be captured under the general issue of exposure to social impacts.
They can affect issuers’ credit profiles and ratings, usually negatively.
“Mitigation of risks associated with elements under social impacts, such as strikes, boycotts and shifting consumer preferences, therefore rests heavily on the level of awareness on the part of the issuers of these underlying shifts, and actions to manage their operations to limit their exposure,” explained Petroleka.
Historically, the pharmaceuticals, energy and natural resources, and tobacco sectors have been at the forefront of either regulatory action to manage social impacts or face various levels of social resistance.
However, the proliferation of social media has also impacted the technology sector.
“[This] is also becoming increasingly exposed to regulatory and consumer shifts in attitudes,” added Petroleka.
Further, Fitch’s ESG scoring methodology shows that some non-bank financial institutions, as well as certain pools of RMBS transactions, face a medium and high impact from social issues and preferences.
Disclosing social issues
To help issuers tackle these challenges, growing awareness of sustainability in the private sector and the incorporation of wider stakeholder priorities in management or investment decisions is resulting in expansion of the inclusion of these metrics into risk management and ESG disclosures.
The EU’s social taxonomy proposal may move social issues into the mainstream and create some basis for alignment.
“The taxonomy aims to identify and direct capital towards economic activities that either address or avoid negative outcomes or generate positive social outcomes,” said Petroleka.
More specifically, the framework will include “do no significant harm” alongside the primarily social objectives.
As taxonomies develop, so will mandatory disclosures. For instance, Petroleka explained the European Commission’s regulations on Corporate Disclosures that are due to take effect for the largest companies as of 1 January 2023 will introduce reporting on social issues.