16 June 2023

BeZero’s approach to Ratings Governance

Mani Gangadharan Venketachalam


7 min

A rating is an assessment of risk or likelihood of an event happening.

A carbon rating is an assessment of the likelihood of a carbon credit delivering on its promise of avoiding or removing 1tCO₂e. 

It is an analytical opinion based on a combination of qualitative and quantitative factors, overlayed with analytical judgement. 

It is not an absolute measure. 

Robust carbon credit ratings cannot be assigned solely through a quantitative model, a questionnaire or even a combination of the two.

It is an involved process.

Therefore, the governance around assigning a rating is one of the most sacrosanct processes at any rating agency. The process needs to be objective, independent, transparent, and backed by analytically robust criteria and clear rating definitions. 

In my experience of working in senior roles in the financial ratings industry for more than thirty years, including as Chief Criteria Officer at CRISIL (S&P Subsidiary), robust ratings governance require six key ingredients:

  • Expertise in risk assessment

  • Cross sectoral knowledge

  • Skills in ‘relative assessments’

  • Consistency in applying criteria and methodologies

  • Time and commitment

  • Internal rating committee

Expertise in risk assessment

Carbon efficacy ratings are an assessment of the likelihood of the carbon credit delivering on its promised 1tCO₂e avoided or removed.

The essential thesis of risk assessment is to dig deep into ‘what can go wrong’, extensively interrogate evidence to onboard expectations/assumptions and bring it all together to arrive at an overall risk assessment. 

This may sound simplistic, but it is an evolved area of expertise prevalent primarily at rating agencies, fixed income research organisations (e.g. sell-side banks) and insurance companies. 

A robust ratings process needs hands-on involvement from people who have this experience.

Cross sectoral knowledge

Sectoral context is the next key ingredient for rating carbon credits. 

Carbon credits can be issued by projects across a wide range of sectors, including Renewables, Afforestation, Reforestation & Restoration (ARR), REDD, Oil Recovery, and Blue Carbon. Each sector has its unique way of how it seeks to avoid/remove emissions from the atmosphere. Understanding these factors are essential to assess the feasibility of the project activities and its likelihood of delivering on its carbon commitments. 

Sector knowledge exists at various levels. For sectors that have been in existence for a number of years (renewables, forestry etc.) there would be a number of people who have worked in the sector and possess a large body of knowledge - these are people who have/can ‘set up and operate’ these projects. 

On the contrary, for evolving sectors (direct air capture, biochar etc) it may be difficult to find ready people with such deep understanding. 

A rating agency requires sector knowledge to understand the sectoral nuances and the relative effectiveness of activities being undertaken - the what and how of avoiding/removing emissions. It is to provide proper context to their rating opinion. 

They are not expected to or are unlikely to have the expertise to ‘set up and operate’ projects. 

This is an important distinction. 

Financial sector rating agencies and research organisations typically rely on this approach. Their primary value addition is to curate the sectoral knowledge and present their opinions on a common ‘scale’ or ‘language’. They do not purport to have knowledge of how to set up / operate the businesses they rate. Few, if any, of the world’s leading ratings or sell-side analysts have had C-suite roles at public companies. 

A robust rating process requires a large number of analysts with deep knowledge of individual sectors and sub-sectors. 

Relative assessment

Ratings are not absolute truths. 

They do not operate on a pass-fail threshold.  

They are relative assessments - comparable in relation to all other ratings - across sectors, countries and other ratings. This helps in a granular assessment of, and pricing of risk embedded in the credits issued by projects. 

It is therefore essential for a sound ratings process to have a common set of people who understand, deliberate and opine on individual ratings across sectors and countries over long time periods

This is achieved by the rating committee. 

Members of the rating committee will always question and challenge the presenting analyst(s) and have to be convinced as to how a proposed rating compares to other ratings within the sector and across all sectors. 

Decision-making is not mechanical. It is a fine analytical judgement. It is developed from attending dozens of rating committees and deliberating on hundreds of ratings over time, across economic cycles.

A robust rating process must have a formal rating committee composed of a common set of individuals who have extensive experience in participating and deliberating at rating committees. 

Consistency in applying criteria and methodologies

Ratings are assigned based on published criteria and methodologies. Consistent application of these criteria and methodologies is expected from the rating process. 

Ratings are complicated. They are analytical opinions based on a range of qualitative and quantitative inputs leveraging various data sources, models, and analytical judgement. 

Rating methodologies are complicated. They are not a simple ‘questionnaire’ which can be answered to arrive at a rating. They are not only the product of running data into a predefined algorithm. Context matters.    

Since ratings seek to provide a common language across sectors, countries and carbon credit types, consistent application of criteria and methodologies becomes an essential prerequisite to the process. 

To achieve this requires a deep understanding of the criteria and methodologies and experience in applying it across a large number of projects. 

This is achieved through the rating committee, whose members have overseen and ensured the consistent application of criteria and methodologies over hundreds of projects. 

This further underscores the importance of a formal rating committee to ensure the robustness of the rating process.

Time commitment

Robust ratings processes require dedicated time and effort to consistently apply predefined criteria and methodologies, factor in sectoral nuances, refine through the art of risk assessment to arrive at a relative grading of risk. 

A typical ratings exercise takes between four and twelve weeks to complete. The proposed ratings involve detailed deliberations at rating committees; few pass (reach consensus agreement) the first time. 

The analysts need to be engaged in it full time. The rating committee members need to be involved in it full time. It is a full time occupation, not a part time advisor/consultant driven process. 

The full time commitment of the entire ratings team and the rating committee is the fifth key element determining the strength of rating governance. 

Internal Rating Committee

The importance of rating committees as the key driver of governance in the ratings process is difficult to argue against. 

A rating committee consisting of a broad membership with various skills and backgrounds ensures that no one analyst can determine and/or influence the rating process. It also ensures that the rating represents the views of the organisation and not a single analyst. 

Rating committees provide oversight over the analytical process, ensure consistency in application of rating criteria and methodologies and comparability of ratings across sectors and countries.

In financial markets, internal rating committees are the norm - rating agencies operate through internal rating committees, who are responsible for assigning and reviewing all ratings. 

Further, the complexities of the ratings process, the experience required to consistently apply criteria and methodologies across ratings, and the onerous time commitment requires that rating agencies operate with rating committees composed only of full time staff. 

This is how premier rating agencies in the financial sector operate. 

An rating committee composed of internal staff is a well proven mechanism to ensure robust rating governance. 

External Rating Committee vs. External Advisory Board

A rating committee responsible for approving all recommendations at a project level and which is composed of external experts could be considered by some to enhance the robustness of a rating process. 

It is argued that external experts may offer deeper greater sector expertise: e.g. sectoral understanding (forests, blue carbon, renewable energy etc.) or in-depth enterprise in a functional area (financial analysis, risk assessment) etc. 

However, most experts either have full time jobs or are engaged in multiple advisory engagements, lending their expertise to multiple companies. Their biggest contribution is likely to be in high level strategic discussions, such as methodology calibration. Their ability to invest meaningful time in understanding, debating and opining on project-level details or debates is rarely equivalent to that of a full time member of a rating committee.

To give an example, a committee would need to give 20 to 30 hours per week to prepare for and participate in BeZero’s Ratings Committee. A commitment of that nature is impractical outside of the salaried staff.

Ratings are also monitored on an ongoing basis. Rating agencies are expected to update their rating as soon as any material event takes place. This requires rating committees to be called at very short notice, several times in a month. It is practically very difficult to operationalise this when it involves external experts who would most likely have other commitments. 

Sectoral experts usually have an unconscious bias towards their chosen sector. This could hinder their objectivity in providing unbiased relative assessments, an essential prerequisite for a credible rating. 

External experts could also be engaged with other firms or commercial activities which could potentially be in conflict with a requirement of absolute independence required of rating committee members.  

It is due to a combination of above factors that rating committees at financial sector rating agencies are constituted of internal staff only - a model which has evolved over time as being the most robust model for ratings governance.

A project by project level External Ratings Committee is however distinct from an External Advisory Board, which BeZero is in the process of formalising membership of. 

Our External Advisory Board will be made up of independent experts across relevant disciplines (finance, policy, sciences) and has a mandate to support the business with rating frameworks and methodologies, analytical approaches, issues such as advocacy, business strategy, and new products or product enhancements. 

Meeting up to six times per year, members will discuss and critically review BeZero’s ex ante and ex post ratings methodologies (as well as new ratings products, such as Sovereign or biodiversity ratings) including our analytical approaches and associated research partnerships. They will not opine on project specific ratings. 

Ratings Governance at BeZero Carbon

BeZero Carbon has learnt from this experience. 

Its rating committees are composed of senior internal staff with expertise in risk assessment across financial ratings and sell-side research, and sectoral understanding across various environmental and policy disciplines. 

Rating committees have a formal governance structure. Each committee has a pre-agreed agenda, designated chair, and has minimum quorum requirement. 

Rating committees are ‘open meetings’. Any rating analyst can attend and contribute at rating committee meetings. They can ask questions and share their views on the rating under discussion. 

Rating decisions are taken only via unanimous vote - this is a higher bar than at financial sector rating agencies, where a simple majority carries the decision. 

All meetings are formally minuted. 

In the last 18 months, BeZero rating committee members have attended more than 200 rating committee meetings (average duration is two hours), and deliberated hundreds of ratings. This unique experience has translated into an unmatched expertise in carbon ratings, difficult to replicate by any other organisation.

This is what differentiates BeZero Carbon Ratings. 

This is what makes BeZero Carbon ratings the most credible risk metric for the Voluntary Carbon Market.

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