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Governance Gains Ground

Over the last 8 months, the pandemic has brought significant uncertainty in global markets and in short and long term economic outlooks. Yet, despite the general uncertainty, it is predicted that COVID-19 will result in accelerated investing in at least one key industry - Environmental, Social and Governance (“ESG”) investing. As mainstream investors such as JPMorgan consider COVID a “major turning point” in ESG investing, we are simultaneously seeing ESG’s importance continue to accelerate in credit.

Last week, Sigma announced a strategic investment by the Fitch Group, the parent company to Fitch Ratings. Fitch, a global data leader, has studied the impact of ESG issues on ratings for several years and its research is telling when it comes to key ESG metrics, particularly governance. In a recent Fitch report on ESG in Credit 2020, Fitch showed that “governance overall is the most dynamic ESG factor from a credit perspective.” Further to this point, a research report co-authored by Fitch Ratings and Sigma on Governance Risk in Banks was also released last week in which Fitch affirmed that financial crime and governance risk are becoming “more ratings relevant”, as authorities, the public and consumers are increasingly conscious of the social impact of the institutions they do business with.

So how will governance risk be incorporated into credit risk analyses in the future?

In the joint research, Fitch leveraged Sigma’s data on three publicly known financial institutions which had significant, recent regulatory or enforcement actions taken against them. Sigma’s proprietary technology - which screens and categorizes thousands of global data sources for non-financial risk information - brought together years of historical risk signals on the three institutions which was then used to conduct analysis alongside Fitch ratings activity over the same time periods.

In the report, Fitch found that while singular risk events vary in their degree of overall impact, patterns and early warning signals in publicly available data can make a potential ratings action more likely. Similarly, it found that a technology solution like Sigma can be effective in uncovering governance risk in a rated entity through the aggregation and distillation of massive amounts of data into risk categories in real-time.

We are in the early days of understanding the impact that ESG factors, including financial crime and governance, have on credit risk. Yet, based on the overall trends we have seen over the last decade and in the wake of the pandemic on ESG, this is a topic of interest that is here to stay.

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