Joshua A. Feltman and Emily D. Johnson are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell Lipton memorandum.
The view that it is not only possible to do well by doing good, but that doing good is critical to doing well in the long run, has come to the fore in the investment community. Environmental, social and governance (ESG) issues are, as State Street says, “a matter of value, not values.” In his much-publicized letter to CEOs, BlackRock founder Larry Fink augured “a profound reassessment of risk and asset values,” noting “climate risk is investment risk.” The statement can be generalized: ESG risk is credit risk. Recognizing this reality, investors have increasingly demanded from companies ESG disclosure alongside traditional financial metrics, with profound implications for corporate credit.
Over time, we expect companies to find their cost of capital more directly tied to their ESG risk, which firms are lining up to help investors evaluate. All of the major credit ratings agencies have signed onto the Principles for Responsible Investment statement that ESG factors can weigh on default probability, and consider such factors in their ratings. Some also offer stand-alone ESG products, as do independent specialist firms. As an indicator of the growing demand for ESG data and analysis, both Moody’s and S&P made strategic acquisitions in the ESG-data space in 2019. Morningstar took a 40 percent stake in Sustainalytics in 2017.
