02-07-2020 14:56

ESG analyst about the importance of ESG in credit risk assessment

Sheida Palmelind, ESG analyst at Nordea Group Sustainable Finance, irons out why ESG factors are important to consider during credit risk assessment.

Six questions to our ESG analyst Sheida Palmelind:

Could you briefly explain what ESG is?

ESG stands for Environmental, Social, and Governance and means that companies are assessed based on factors related to these general themes. Different types of sectors and businesses face different kinds of ESG risks and opportunities.

For E (environmental), I look at how a company’s business affects the environment it is surrounded by or depending upon. Climate risk is often included in ‘Environment’.

For example, how a building such as an office or a production facility affects its surrounding environment, during its construction as well as once in use, is considered in the analysis. We are also interested in the opposite, i.e. how resilient the building and the business are to climate change. Hotter summers, more frequent storms, rising sea levels can pose risks, as well as sharpened environmental requirements.

For S (social), we want to understand how a project or company affects surrounding community as well as its employees. Areas of focus are workplace safety, labor rights, diversity and inclusion, as well as human rights due diligence for projects. Staff and workers are important for any type of business and proper investment in human capital is important for future profitability, as is the community’s approval of the business operations in the area.

For G (governance), an ESG analyst investigates how the company or project is managed in terms of management systems, transparency and stakeholder communication. Governance can mean many things and is of course relevant for a so called traditional analysis as well as financial crime analysis. A way of confirming that the ESG management systems are working is to investigate if companies are involved in controversies which relate to ESG areas. This is not only important from an ESG risk profile, but also from a reputational risk standpoint.

So how is ESG analysis carried out?

First, there is a need to understand the material risks for the industry the customer belongs to as well as our relationship with them i.e. what are we financing. The analyst collects information from the company itself as well as third-part data providers and then reviews material linked to the material risks and investigates any indications of involvement in controversies or business we do not finance. In terms of information we are looking at annual reports, sustainability reports, sustainability metrics, climate maps, regulations, certifications and news scans. We also have a dialogue with customers when needed and when requested by customers wanting to know more about Nordea’s sustainability management. The ESG analysis and rating is then included in credit and business decisions as well as portfolio risk management.

Why does Nordea conduct ESG-analyses?

This question has two answers:

Firstly, ESG risk and opportunity management is linked to companies’ long-term survival and profitability. A company that manages ESG risks and is industry leading in terms of opportunities can achieves larger market share if there are changes in climate requirements, changes in preference in terms of community approval of projects as well as changes in consumer behavior related to ESG concerns. It is also important to attract and retain talented workers and staff as well as ensure that any risk of corruption and fraud is mitigated.

Secondly, the ESG analysis and rating of customers is part of Nordea ESG risk management. We need to understand the risks we are exposed to as financiers, both on customer and portfolio level..

So how does and ESG analysis differentiate from a ”regular” company analysis?

One aspect is that conducting ESG analyses is still a relatively new occurrence, hence there is no fixed framework, compared with a so-called regular risk analysis. That also means that necessary information is not always readily available since companies are not required to report on ESG management and metrics. Also, the information available is not regulated the same way as financial information, which means that the analyst must find other ways of validating a company’s claims. ESG relevant factors are not always quantifiable and the analyst must be able to draw conclusion regarding a company’s management of “soft” ESG risks using reports, understanding of the underlying issues as well as keep up on current research and industry trends. Sometimes quantifiable data can mean mapping a company’s production sites to climate maps showing water-stress, flooding or storm paths.

Many times it is up to the ESG analysis to solve issues with data availability, but that is also what makes ESG such an interesting field to work in.

“Customers are reaching out to us because they want to discuss these aspects and are reporting their ESG work”

Can you see that the interest in ESG analysis is on the rise?

Yes, definitely. When I started, it was not uncommon to receive questions about why an ESG analysis was being made or whether it was really necessary – both from other analysts and customers. But now, customers are reaching out to us because they want to discuss these aspects and are reporting their ESG work.

Sheida, earlier you said jokingly that you have the ”best job in the world”… why is working with ESG analysis so much fun?

Good question!

It’s both exciting and challenging to work within an area that is constantly growing and developing. It keeps me on my toes to always be ready to evolve in my profession and learn about new occurrences and areas of analysis. It has always puzzled me why ESG factors have not always been considered in traditional analysis. I mean, say that a company operates in a limited demographic context and starts affecting the surrounding area in a negative way (tax evasion, discrimination, poor working conditions, etc.) it will in turn affect its financial prosperity negatively long-term due to the company itself being dependent on the approval of the surrounding community as well as the pool of workers. So, considering ESG risks is in the best interest of every company.

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