17-D-0558
September 29, 2017

Necessity to Consider ESG Factors for Credit Ratings
Japan Credit Rating Agency, Ltd. (JCR) signed on September 15, 2017 an “Initiative on ESG in Credit
Ratings Statement,” initiated by United Nations Principles for Responsible Investment (UNPRI). JCR
has been incorporating CSR and other factors into its credit ratings, and decided to explain the current
status concerning necessity of consideration of ESG (environment, social and governance) factors,
taking the opportunity of the signing.
1. Introduction
JCR has been incorporating ESG factors to date from a viewpoint of CSR (corporate socialresponsibility). Please refer to JCR’s press release titled “CSR’s Position in Credit Rating,” dated
December 28, 2004, published in Japanese only, etc. Along with recent firm establishment of 2 codes,
stewardship and corporate governance codes, business and investment activities are changing.
Understanding of concept of ESG is widely spread and there are an increasing number of cases
where corporations and investors are taking measures for the ESG factors. In every region in Europeand U.S., ESG investments have been activated ahead of Japan. Japanese corporations which are
well globalized, in particular, are strengthening initiatives for ESG issues.
It is necessary to consider ESG factors in assessment of various elements of JCR’s defined crating
rating methodologies. JCR explains in this report afresh what kinds of elements can have an impact on
credit ratings from a perspective of ESG factors.
2. Overview
JCR pays attention to the following elements for a possibility that ESG factors can have an impact on
credit ratings:- Impact by ESG factors on issuers’ sustainability- Impact by ESG factors on cash flow generation capacity required for debt redemption- Impact by initiatives for ESG on fundraising ability
JCR incorporates ESG factors that could come to the surface within approximately 3 years,
because JCR decides credit ratings in view of debtors’ conditions and business environments in thecoming 3 years or so.
JCR grasps issuers’ conditions for ESG factors through issuers’ general disclosure of information.
Many Japanese issuers have been holding a series of discussions on enhancement of disclosures ofinformation on ESG issues, and there are many cases where such disclosures have not reached asatisfactory level. To offset these conditions, JCR is making efforts to obtain more detailed information
and accurate understanding through management interviews and other tools. In particular, JCR
considers that management interviews are very important to check ways of governance.
3. Impact on Issuers’ Sustainability
JCR assigns a long-term issuer rating to debtors by grasping their overall debts in a comprehensiveway. The long-term issuer rating is an assessment on creditworthiness of a debtor as a going concern,and an assessment as to whether the debtor can continue its business on an ongoing basis and canconstantly create cash flows required for debt redemption. As ESG factors are highly related to
debtor’s business continuity, analysis of ESG factors cannot be downplayed from this point of view.
Corporate management contains various risks, some of which are controlled by taking an proactive
stance on ESG factors. From a perspective of this risk management, ESG factors are related tocorporate sustainability.

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4. Impact on Issuers’ Cash Flow Generation Capacity
Credit ratings denote "certainty of fulfillment of debt obligations as initially agreed." Therefore,
assessment of cash flows that are resources of repayment is important. JCR considers ESG factors as
follows:(1) Environment
JCR considers it is necessary to assess environmental factors from 2 approaches: (i) assessment ofindustrial characteristics themselves; and (ii) assessment of individual corporations.
In industries where environmental initiatives are required because, for example, they face issues
such as large greenhouse gas emissions in their business development, corporations might berequired to change their business portfolio in the medium and long run in addition to requirements for
reduction of such emissions and raising environmental contributions from products. While JCR
considers attention should be paid to a possibility that the current state of business structure or cash-in
will drastically change in these industries, JCR in practice assigns credit ratings, focusing on risks that
could come to the surface in the next 3 years or so.
JCR examines very carefully cash-in and cash-out for initiatives by individual corporations asfollows: In terms of cash-in, JCR pays attention to presence of environmentally friendly products orservices and their competitive strengths, given the fact that the number of consumers and corporations
which place importance on environment is increasing. In terms of cash-out, JCR checks cost burden ofenvironmental initiatives. In particular, manufacturing industries are required to take environmental
considerations into account for raw materials procurement and waste in the manufacturing process
and are being affected in many cases by strict regulations. Certain costs including costs for switchoverof resources, capital investments, R&D investments, etc. are required in these cases.
(2) Social
Corporations are built on relations with many stakeholders rather than independently existing. It isindispensable to maintain an appropriate relationship with shareholders, customers, consumers,employees, and so on for smooth corporate business expansion.
In particular, labor shortage has become considerable and social requirements for improvement ofwork environment have intensified in recent years. Initiatives by corporations for these issues now
influence their competitive strength and cash flow generation capacity.
(3) GovernanceTransparency of management decision-making, appropriate management and supervision of businessincluding that of subsidiaries and thorough compliance are becoming more and more important forsustainable business development of corporations.
While business activities have become increasingly globalized, there are many cases whereexternal environments significantly change in a short period of time. It is essential to have amanagement structure in which corporations can fully discuss large investments, etc. in order to makea fast and accurate decision on such issues under these situations. JCR sees that an appropriate
management decision can lead to an appropriate allocation of cash flows, investment and creation offuture cash flows.
There are many scandals of corporate subsidiaries including overseas ones. It is becoming moreand more important to establish a structure for ensuring accuracy in execution of business includingthat of subsidiaries to control inappropriate cash-out.
Stricter measures are required for compliance in recent years. Scandals with respect tocompliance have a negative impact on business development and cash flow generation in variousaspects. For this reason, it is indispensable not only to institute accurate and specific internal rules, butalso to establish a structure where such rules can be applied in an appropriate manner includingchange of employees’ awareness.

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5. Impact on Issuers’ Fundraising Ability
It is indispensable for a corporation to raise funds in a smooth and appropriate manner to expand
business on a continuing basis. Ability to raise funds is an important factor for credit rating analysis. As
ESG factors have become more important in making investment decisions by investors in recent years,
impact of initiatives for ESG on their fundraising has also increased.
6. Impact of ESG Risk Events on Credit Rating
There have been already cases where ESG risk events could have become factors for credit ratingchanges in aspects of both qualitative and quantitative assessments. Given this situation, JCR always
monitors presence of any risk events, and if there are any ESG risk events that have occurred, JCR
grasps the outline and size of impact and reflects them in its credit ratings.
While assessment items and their importance differ depending on individual credit rating cases,
the following are major items that are checked as an example.
(Example)- Whether efforts for investigation to determine cause and for preventive measures are being
made in an appropriate manner;- Whether business expansion can be constrained by regulations and punishments;- Where worsening of reputation can lead to a lower revenue and lower competitive strength;- Whether a large amount of cash-out can occur due to compensation and restitution fordamage;- Whether remedial measures are associated with large cost increase;- Whether fundraising can be adversely affected by worsening of business relations withfinancial institutions.
Yoshinori Namioka
Japan Credit Rating Agency, Ltd.
Jiji Press Building, 5-15-8 Ginza, Chuo-ku, Tokyo 104-0061, Japan
Tel. +81 3 3544 7013, Fax. +81 3 3544 7026
Information herein has been obtained by JCR from the issuers and other sources believed to be accurate and reliable. However, because of the possibility of human or mechanical error as well as other factors,JCR makes no representation or warranty, express or implied, as to accuracy, results, adequacy, timeliness, completeness or merchantability, or fitness for any particular purpose, with respect to any suchinformation, and is not responsible for any errors or omissions, or for results obtained from the use of such information. Under no circumstances will JCR be liable for any special, indirect, incidental orconsequential damages of any kind caused by the use of any such information, including but not limited to, lost opportunity or lost money, whether in contract, tort, strict liability or otherwise, and whether suchdamages are foreseeable or unforeseeable. JCR's ratings and credit assessments are statements of JCR's current and comprehensive opinion regarding redemption possibility, etc. of financial obligations assumed
by the issuers or financial products, and not statements of opinion regarding any risk other than credit risk, such as market liquidity risk or price fluctuation risk. JCR's ratings and credit assessments arestatements of opinion, and not statements of fact as to credit risk decisions or recommendations regarding decisions to purchase, sell or hold any securities such as individual bonds or commercial paper. Theratings and credit assessments may be changed, suspended or withdrawn as a result of changes in or unavailability of information as well as other factors. JCR retains all rights pertaining to this document,
including JCR's rating data. Any reproduction, adaptation, alteration, etc. of this document, including such rating data, is prohibited, whether or not wholly or partly, without prior consent of JCR.
JCR is registered as a "Nationally Recognized Statistical Rating Organization" with the U.S. Securities and Exchange Commission with respect to the following four classes. (1) Financial institutions, brokers
and dealers, (2) Insurance Companies, (3) Corporate Issuers, (4) Issuers of government securities, municipal securities and foreign government securities.
JCR publishes its press releases regarding the rating actions both in Japanese and in English on the same day. In case that it takes time to translate rating rationale, JCR may publicize the summary version, which
will be replaced by the full translated version within three business days. (Regarding Structured Finance products, JCR only publicize the summary version in English.)©Japan Credit Rating Agency, Ltd. All rights reserved.
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