Why ESG matters in credit analysis. Over the last two decades, credit analysis has increasingly considered ESG factors as part of the assessment of the credit worthiness of a borrower. Analysts have increasingly considered environmental liabilities of oil companies and a range of governance factors when assessing companies. The growing focus on ESG is supported by the fact that industry studies have demonstrated that ESG integration techniques can help identify unknown or undervalued credit drivers. And the material ESG issues can be key drivers of credit quality. There are different ways in which ESG factors impact fixed income instruments issued by companies, municipalities, and governments. In broad terms, they impact the price, performance, and credit risk of a bond at two levels. Firstly, at the issuer level, i.e. the company level, and secondly, at the industry and geographic level. The issuer level impact stems from factors that do not affect the whole market. Those issuer-level factors include the company governance, company reputation, balance sheet strength, or regulatory compliance. The industry and geographic level impacts stems from wider ranging issues, such as technological changes, the market the companies sell to, regulatory changes, or legal factors affecting the whole industry. In the climate change space, the issues of relevance may relate to both transition and physical risks. Transition risks stem from the need to adapt to changing market environment rules and regulations. Physical risks are those where changing climate physically impacts the company's assets.

ESG factors impact the issuer's operations and financial performance, which in turn leads to reassessment of pricing of fixed income securities as credit spread changes ESG factors influence not only the company's operations, financials, and yield on its bond, they also impact the issuer's ability to actually issue new bonds, to finance new projects, or refinance maturing debt. There are numerous instances where ESG failures led to negative impact on the value of fixed income instruments. These include the Volkswagen emissions scandal, in which the company misled the regulators by only activating its vehicles' emissions controls under laboratory testing. The scandal impacted the reputation of Volkswagen significantly, and the value of the company's equity and debt declined by more than $20 billion, in addition to the multi-billion dollar penalties the company had to pay. Another example is the aircraft manufacturer Boeing, whose shareholders and debt holders suffered as the company was forced to ground and redesign parts of their main narrow body product. As in the Volkswagen case, the company's shares and debt instruments suffered a significant decline in value. The failures were traced to governance factors such as poor performance of the board of directors partly due to the board members' lack of adequate experience in product safety.