A Closer Look at ESG's Corporate Governance Component | ETF Trends

Socially responsible investing that tracks factors like environmental, social, and governance principles is more than just a feel-good phenomenon. They can affect credit risk and investment performance.

For example, S&P Global Market Intelligence incorporates the ‘G’ component in an analysis of credit risk. Their proprietary Credit Assessment Scorecards can provide a structured framework for assessing credit risk, generating credit scores that are designed to broadly align with credit ratings from S&P Global Ratings.

The analysis of corporate governance describes how a firm’s rules, practices, and processes can influence its credit profile. For example, independent and diverse boards, along with effective control systems and transparent communication, can help drive operational success and mitigate risks, including those related to fraud and conflicts of interest, according to Marco Sindaco, a director within the Risk Solutions team for S&P Global Market Intelligence Credit Assessment Scorecards in South of Europe.

On the other hand, corporations can be dinged if controlling shareholders promote their own interests over the minority shareholders and other stakeholders. Additionally, accounting restatements and regulatory and legal infractions are also signals for weak governance practices.

“In the Scorecard framework, governance can either have a neutral or negative impact, but cannot enhance a credit assessment. This is because stronger M&G practices are expected to have already manifested themselves in stronger competitive positioning and more balanced financial risk profiles,” Sindaco said.

“Conversely, poor planning and controls, lack of independence and preparation, and legal and regulatory infractions can be regarded as early-warning signals of a firm´s weakening business and financial conditions. A single governance deficiency does, accordingly, act as a modifier to the credit assessment,” he added.

According to S&P Global Ratings, the governance aspect can be broken down into four risk factors relating to how a company is managed.

  1. Its relationship with shareholders and other stakeholders, and how its internal rules, practices, and processes either create or mitigate risks, including ownership and board effectiveness
  2. Management culture and internal controls
  3. Transparency and reporting
  4. Regulatory, tax, and legal frameworks and infractions

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