The Effects of ESG on Credit Management
In the finance industry the theme ESG is already omnipresent. But also in the economy in general, sustainable criteria are playing an ever-larger role in strategic decisions, not least because of political initiatives such as the German Supply Chain Act, which is expected to be followed by similar legislation at EU level.
So what, exactly, does ESG mean? Why will ESG have an influence on credit management in companies in the future? And how will relevant information be obtained and used for evaluation?
You can find the answers in our article.
What Does ESG Mean?
The three letters stand for "Environment, Social and Governance" and collectively represent the aim of comprehensively sustainable business management that takes into account both environmental and social aspects.
The consideration of ESG criteria when making financial decisions can be seen to have increased in the finance industry in recent years. This has been provoked, on the one hand, by the changing demands of the stakeholders, and on the other hand by regulatory requirements, for example on the part of the EU, which in 2019 committed itself to taking a leading global role in combating climate change.
ESG in the Private Sector?
Logically, the megatrend sustainability does not stop with the financial services sector. Other companies increasingly want and need to consider how sustainability can be taken into account in their business decisions.
Here also, there is pressure from two sides. Society demands a new and transparent behaviour of companies and the politicians are creating pressure with initiatives such as the German Supply Chain Act, which will probably soon be followed by legislation at EU level. Further initiatives can be expected.
ESG: Influence on Credit Management
For capital-market-orientated companies above a certain size there are already reporting obligations in relation to corporate social responsibility. From 2023, as previously discussed, there will be evaluation obligations for particular companies in relation to the Supply Chain Act. And it is to be expected that the legal requirements will be increased further in future.
These requirements naturally lead to the suppliers of the companies with reporting obligations needing to provide reports or the corresponding certification themselves, otherwise the position of the companies with the reporting obligations would deteriorate.
As a consequence, business will only be done with companies that also have good evaluations according to ESG criteria. This will have direct effects on the turnover of companies – and therefore on their rating and evaluation by credit managers.
ESG ratings help with evaluation
An ESG rating or ESG score can provide information on how sustainably a company is positioned. In Germany, companies such as Creditreform and SCHUFA are developing such solutions. Internationally, Refinitiv already offers ESG scores, for example.
The difficulty with these ratings is that each information provider develops its own procedure and there is no unified worldwide method for creating ESG scores – so the situation will be the same as for the interpretation of reports in general.
For information service providers, a pre-requirement for the determination of ratings is that the company concerned performs detailed reporting so that relevant data for evaluation can be obtained. Commitments by the company to the observation of general standards or the existence of certification can also serve as indicators.
It is possible that these ratings will at first only be offered for larger companies. In the long term, however, market forces will compel all companies to publish details of their activities in these areas even if there is no legal obligation to do so.
ESG Activities Will Influence Company Performance in the Long Term
In the short term, ESG ratings are certainly an indicator of the positioning of a company and therefore provide additional information for credit allocation. In the longer term, however, the activities of the company in the area of ESG will have an effect on the company's performance. These aspects of evaluation will then certainly be utilized directly in the ratings of the financial stability of companies.
Especially in credit management, one should be prepared for these changes. Evaluations of the rules on supply chain diligence could be an initial anchor point for this.
Such evaluations and also an overall solution can only be performed efficiently with the help of appropriate IT systems.