There is plenty of evidence showing that companies with poor environmental, social and governance (ESG) behaviours are likely to underperform their peers. Our research has historically included ESG analysis alongside assessments of a firm’s operating and financial risks. Until now, it has been challenging to price ESG risks in a similar way to these core credit risks. But this is changing: in order to analyse ESG risks with greater precision, we have developed a pricing model to capture the influence of these factors on credit instruments.
To price ESG risk, we took Hermes’ proprietary measure of ESG risk – the QESG Score – for companies in four credit-default swap (CDS) indices. Drawing on external specialist research and the proprietary insights of Hermes EOS, the QESG Score combines a company’s current and future expected levels of ESG risk. We then compared each issuer’s QESG Score with the spreads on their CDS to identify persistent correlations. Our major findings are as follows: