ESG IDP Methodology for Identifying Credit-Materiality

9th January 2023 – The ESG Integrated Disclosure Project (ESG IDP) sought to prioritize the most relevant ESG questions for credit investors.  Questions were organized by those most likely to matter for all borrowers and questions which were material depending on the specific industry sector. 

The industry-specific questions in the template are based on Sustainability Accounting Standards Board (SASB) Standards per the SASB SICS® based on the borrower’s selection of industry(ies). The questions in the ESG IDP template represent a subset of SASB Standards Disclosure Topics by industry. The subset represents the disclosure topics that were prioritized by the ESG IDP as the most relevant for borrowers following the application of the ESG IDP Industry-specific Methodology. This ensured that the guiding principles of proportionality and credit-materiality were at the heart of our methodology.

Proportionality

Pairing a robust set of general questions, and industry-specific questions can quickly become difficult for companies in the private credit or broadly syndicated loan markets to complete comprehensively.  Informed by PRI’s ESG Factor Map and with this in mind, ESG IDP working group members focused on curating a set of 3-5 industry specific questions for prioritization.  ESG IDP recognizes that developing corporate knowledge and capacity to populate and quantify robust industry specific questions takes time.  Beginning with a subset of factors of most relevance to lenders that are operationally core to the business represents a valuable starting point. Companies with more mature reporting capabilities should endeavor to complete the remainder of the industry specific questions as the template provides a global baseline for all businesses without holding back others with more capacity to report.

• Not all industries have the same number of material issues prioritized within the SASB Standards. Industries with a higher number of material issues or industries subject to stronger regulatory oversight factored into determining the total number of industry specific questions.

Credit-Materiality

The SASB Standards establish a global baseline for issuer to investor disclosure of financially material ESG information. Relative materiality within the SASB Standards is driven by several factors such as asset class and time horizon.  Determination of the relative materiality most appropriate to credit investors is based on the SASB Standards Disclosure Topic Financial Impact Channels.  These Disclosure Topic Financial Impact Channels identify 13 channels of financial impact where an ESG issue can affect factors within the income statement, balance sheet and risk profile of the company.  The Methodology has identified that six of these 13 financial impact channels have strongest credit-relevance:

• Capital Expenditures
• Cost of Capital
• Extraordinary Expenses
• Industry Divestment Risk
• R&D Expenses

Credit Investors providing capital with equity terms and provisions may find value in exploring the full SASB Standards or assessing the other financial impact channels.  Full access to the Disclosure Topic Financial Impact Channels can be procured through the International Financial Reporting Standards (IFRS) Foundation.           

An ESG factor captured by a Disclosure Topic may affect multiple financial impact channels and affect them with different degrees of magnitude.  Magnitude and the financial impact channels formed part of the basis for the credit-relevant determination of the SASB Standards Disclosure Topics and were not a subjective determination made by the ESG IDP.

Within the credit-relevant six financial impact channels, the Methodology used the number of links between a Disclosure Topic and financial impact channels as well as the degree of magnitude to select the 3-5 prioritized questions.  The outcome of this selection criteria did not always produce a clear set of 3-5 factors.  In these circumstances the working group within the organizations supporting the ESG IDP’s development noted here were tasked with the oversight of this process and reviewed Disclosure Topics with comparable materiality evidence. In these cases, an increased focus was given to the CapEx, Cost of Capital, and Cost of Revenue channels and the application of dynamic materiality.  SASB Standards Codification occurred in November 2018 and industries and markets have changed in a meaningful way since then.  Dynamically emerging material issues, already captured within the industry standards, were therefore incorporated into the prioritization determination when reviewing the few inconclusive industry prioritizations produced by the Methodology.    I would be happy to answer any questions regarding the Methodology and welcome constructive feedback, both of which can be directed to info@esgidp.org.

Jeffrey Cohen
Head of ESG & Sustainability
Oak Hill Advisors
Vice Chair of Executive Committee of ESG IDP