February 1, 2022
SEC Staff Report on Credit Rating Agencies Addresses ESG Risks
Yesterday, the Staff issued its annual Staff Report on Nationally Recognized Statistical Rating Organizations (NRSROs), providing a summary of the Staff’s examinations of NRSROs and discussing the state of competition, transparency, and conflicts of interest among NRSROs. This report is required by Section 6 of the Credit Rating Agency Reform Act of 2006 and Section 15E(p)(3)(C) of the Exchange Act. The report is prepared by the SEC’s Office of Credit Ratings.
The report covers a lot of ground in the realm of credits ratings, but one particular area caught my attention. As noted in the report, during 2021 inspections of NRSROs, the Staff focused on several areas of risk related to ESG factors. The report notes:
Development in the area has grown rapidly, and competition has increased among NRSRO and non-NRSRO providers, leading the Staff to identify several areas of potential risk to NRSROs. These include the risks that, in incorporating ESG factors into ratings determinations, NRSROs may not adhere to their methodologies or policies and procedures, consistently apply ESG factors, make adequate disclosure regarding the use of ESG factors applied in rating actions, or maintain effective internal controls involving the use in ratings of ESG-related data from affiliates or unaffiliated third parties. The Staff also identified the potential risk for conflicts of interest if an NRSRO offers ratings and non-ratings ESG products and services.
The Staff notes that examples of non-ratings ESG products and services include: (i) evaluations of the environmental benefits of a project financed with the proceeds of a “green” bond issuance; (ii) ESG scores based on the expected impact of ESG factors on a company’s growth, profitability, capital efficiency, and risk exposure; and (iii) assessments of a company’s risk from climate-related scenarios. The Staff indicates that these products and services are not credit ratings and are therefore not directly regulated by the SEC’s Office of Credit Ratings.
– Dave Lynn