Exploring the Role and Responsibility of Credit Rating Agencies in the Transition to a Sustainable Economy

Credit rating agencies (CRAs) have played an increasingly influential role in global capital markets over the last three decades and the ratings they assign to the debt issued by corporations, financial institutions and sovereigns are used to guide the investment and capital allocation decisions of the world's largest investment managers and asset owners. In recent years, CRAs have been criticised for their role as "key enablers" of the financial crisis. Policy makers, recognising that rating agency decisions have potentially systemic consequences and impact public finances, continue to debate their role, function and influence on governments, companies and markets. Drawing on stakeholder theory and utilising a mixed methodology for data gathering that combines desk-based research and qualitative interviews, this paper identifies the key stakeholders for CRAs in relation to sustainability for the first time and presents their emerging views on the role and responsibility of the ratings industry in the transition to a sustainable economy. This paper argues that the industry does have a role to play in this transition. However, this role is yet to be defined by stakeholders, or acknowledged by CRAs. It finds that CRAs do not yet embed consideration of Environmental, Social and Governance (ESG) issues in their ratings criteria or processes in any systematic and transparent way, while the regulatory reform agenda for CRAs also largely ignores sustainability issues. This suggests that the current rating methodologies and analytical approaches of the CRAs are themselves largely unsustainable. It argues that CRAs that do not systematically and transparently integrate ESG issues within their criteria and ratings are actually increasing – rather than simply measuring – credit risk for individual issuers and raising systemic risk for the market as a whole, while at the same time creating negative outcomes for capital markets, the environment and society. It finds that a greater focus on ESG issues by CRAs will enable them to provide a more credible and holistic assessment of the credit risks facing issuers, help the industry rebuild its reputation following the financial crisis and retain a license to operate which is increasingly under threat of withdrawal by regulators and investors, and incentivise investors, issuers and other market participants to devote greater attention to sustainability issues