Incorporating ESG factors in commodity trading credit risk assessments: Overcoming the data challenge

Let’s start with the aligning credit risk appetite and ESG strategy

As a starting point, companies need to incorporate ESG into their determination of their credit risk appetite. This should reflect their underlying corporate ESG strategy and either hard or soft requirements of lenders and shareholders.

Overcoming the challenge of unreliable, incomparable data

Historically, companies have been held back by a lack of granular, robust, comparable data around ESG factors. However, as ESG reporting requirements evolve, this data is increasingly becoming available. The challenge is to use the available data effectively. Companies need to ensure it is from a reliable source, up to date, and covers all counterparties etc - which requires a clear and robust methodology and strong data governance.

Environmental risk reporting is perhaps the most developed and is increasingly considering not just the impact of the entity on the environment but also the risk of climate change on the entity. The increasing number of companies reporting under the Task Force on Climate-Related Financial Disclosures (TCFD) guidelines will make the collection of data easier for UK and EU companies, but the challenge of international comparability remains.

Social considerations are currently more underdeveloped, primarily as they are hard to quantify except if something goes wrong. But clearly assessing a company's likelihood of breaching their obligations in respect of employees, customers and suppliers, is fundamental to the credit risk process.

Governance needs to be considered both at the wider regulatory environment level in which a company operates and also from an internal perspective.

Four things you need to do now

1. Align your credit risk methodology with your overall ESG strategy to ensure appropriate weighting is given to ESG metrics in counterparty risk assessments.
2. Maximise the reliability, comparability and completeness of your data points between companies and years, using independent third party data where possible. More and better ESG data is increasingly available from established third parties.
3. Refresh your policies, processes and controls to ensure the approach to incorporating ESG factors in credit risk assessments is robust and reflects the underlying corporate ESG strategy.
4. Invest in your counterparty credit tools and technology to both support the risk assessment process, and provide insightful credit exposure reporting and metrics for both internal and external consumption.
   

We can help you develop your ESG data informed credit risk approach

We are working with leading commodity traders to better incorporate ESG into credit risk decisions. Please get in touch if you would like to discuss how we can help you develop your strategy, operating model, technology and reporting capabilities.