Skip to content Skip to Search
Skip navigation

ESG factors will depress Middle East’s credit ratings

Climate risks, social issues and governance standards will bear down on region's businesses

ESG Middle East credit ratings Reuters//Abdel Hadi Ramahi
Floods in the UAE in 2022: Climate risks are among the ESG factors that will depress the credit ratings of Middle Eastern governments and businesses

How should the GCC interpret Standard and Poor’s decision, taken last month, to stop issuing separate ESG (environment, social and governance) scores on the governments and companies that it rates?

Was the agency caving in to political pressure, or simply recognising that assigning a standalone ESG rating is analytically unsafe when there is still so much uncertainty about the impact that its factors have on companies’ financial performance?

The answer will have a significant impact on regional credit ratings in the years ahead, and on the ability of governments and companies in the GCC and the wider Middle East to access investment and finance their deficits.

S&P says that it will continue to include “narrative paragraphs” about companies’ ESG exposure in their rating reports. But in future this narrative will not be distilled into a single alphanumeric score (A+, A, A- etc.)

The ratings agency is being investigated by nearly 20 US states, mostly Republican-controlled, which are alleging that the agency is “politicising” credit ratings by including non-financial factors in its analysis. Doing that violates US laws on consumer protection, the states say. 

In 2022, S&P assigned ESG ratings to US states that, in most cases, were either “neutral” or “moderately negative”. For state authorities that hold AAA credit ratings, such as Utah and Texas, even a “neutral” score can be seen as a threat to their pristine credit ratings. 

Credit ratings matter not only because they affect the cost of borrowing but also because high ratings are a source of pride, particularly for governments and local authorities. 

The states’ complaints will be familiar to anyone who has assigned credit ratings for one of the big agencies, as I did for Moody’s some years ago.

Simply put, if those states had received top ESG ratings, they would be trumpeting their credentials to anyone who would listen. But when they receive a lower score that threatens their AAAs, they go on the attack. 

S&P should have stood its ground, just like it does when it downgrades credit ratings on governments, local authorities and big companies.

But there is a problem here. 

Unstable methodologies

S&P – and other credit rating agencies – are being told by their regulators to include ESG factors in their rating analysis. They are also being asked to demonstrate how they are doing that.

Investors also demand information on companies’ environmental footprints, and the extent to which climate-related factors may affect their financial strength in the years ahead. 

The credit rating agencies want to show that they understand how ESG factors can affect bond issuers’ ability to meet their repayment obligations. But there is no historical data that can be modelled to help predict future defaults.

ESG-related risks are changing all the time.

Governments introduce new climate-related policies, such as tax incentives for renewable energy production.

And social expectations change – who knows what working conditions will be considered “acceptable” for a company’s garment-making subsidiary in Dhaka five years from now, ten years from now, and beyond?

The methodologies for assigning ESG scores are unstable and, for the moment, it is impossible to validate their predictive power. 

In contrast to S&P, Moody’s continues to issue distinct scores on ESG profiles of the companies and countries that it rates.

The firm’s Credit Impact Scores (CIS) indicate the extent to which ESG factors are weighing, either positively or negatively, on the client’s overall credit rating. 

So, when Moody’s assigns a “highly negative” or “very highly negative” CIS (which would be 4 or 5 respectively) the agency is saying that the overall rating is lower than it would be if ESG factors did not exist.

Moody’s assigns CIS scores of 3 (“moderately negative”) to five of the six GCC states. Bahrain has a 4.

No rated country in the Middle East has a Moody’s CIS score of 1 or 2, meaning that in every case ESG factors are depressing the overall credit rating rather than strengthening it. 

Ratings can still improve

ESG scoring has come a long way in recent years. Despite the challenges involved, we must expect them to become more consistent, more transparent and therefore more widely used in the years ahead. 

It is surely only a matter of time before S&P reinstates some form of alphanumeric ESG scoring.

Moody’s will continue to refine its CIS scores, and the other agencies will also develop their rating opinions: Fitch already assigns Climate Vulnerability Scores: “Climate.VS”. 

Middle Eastern governments may not be complaining about their ESG scores in the same way as the US states that are taking on S&P.

But unless they reduce their exposure to climate risks, improve public policy on social issues, and strengthen governance standards, their credit ratings will continue to be depressed by ESG factors, rather than pulled up.

Andrew Cunningham writes and consults on risk and governance in Middle East and sharia-compliant banking systems

Latest articles

Suriname oil

QatarEnergies buys into Suriname oil expansion

The state-owned giant QatarEnergy has signed a deal with US oil company Chevron to acquire a 20 percent interest in a production-sharing contract for an offshore concession in the South American country of Suriname. Chevron will keep a 40 percent interest in Surname’s block 5, as will Paradise Oil, an affiliate of Suriname’s national oil […]

Rakbank

Rakbank plans first bond to fund social projects

The National Bank of Ras Al Khaimah (Rakbank) is planning to launch its first social bond issuance, a news report has said. The Abu Dhabi-listed bank is seeking bids for the five-year benchmark-sized dollar-denominated bond, Reuters reported. The initial price was set at 170 basis points over US Treasuries, with the final pricing expected on confirmed […]

The proposed sharia standard 62, which aims to transition the industry towards asset-backed sukuk, will not affect 2024 issuance, says S&P

Sharia standard 62 may disrupt sukuk market, says S&P

Global sukuk issuances are likely to suffer next year if the proposed standard 62 sukuk changes to sharia guidelines are implemented, according to the American credit rating agency S&P in a new report. “Adopting Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standard 62 guidelines as they have been presented could disrupt the market,” […]

Videos released last month show construction of the Royal Arts Complex at King Salman Park is well underway

Full steam ahead on ‘largest urban park in the world’

Saudi Arabia is forging ahead with construction of what it calls the “largest urban park in the world”, publishing videos of its first buildings under construction after a tunnel opened earlier this year.  King Salman Park in Riyadh is owned by the Public Investment Fund and was recently valued by real estate consultancy Knight Frank […]