TwentyFour Asset Management
The inexorable growth of sustainable investing during the last decade is likely to continue without interruption given the experience of COVID-19 has only intensified investor and regulatory focus on environmental, social and governance (ESG) issues globally.
Once characterised as the 'neglected child' of sustainable investing, the tide is turning in fixed income with ESG themes featuring as prominently now for bond investors as their equity focused counterparts. Likewise, companies globally now recognise that a failure to engage and meet the demands of debt investors on sustainability can profoundly influence their cost of capital.
However, despite the more widespread adoption of ESG analysis in bond investors' analytical frameworks, the availability of consistent and illuminating data often poses a challenge for holders of fixed income globally.
At TwentyFour, as an active manager with both an ESG integration framework and a growing sustainable offering, we have had countless engagements with bond issuers of all types on this issue and we have provided tips for issuers detailing how they can improve sustainable bond investors' data.
1. Don't attempt to fool us
Issuance across green, social and sustainable bonds hit a record high of $264bn in the first quarter of 2021, according to Refinitiv data, and the upward trajectory is showing no signs of slowing with Moody’s expecting global issuance of sustainable bonds to hit $650bn this year.
The deluge of issuance inevitably raises the question of 'greenwashing', which is only exacerbated by a lack of definitive standards – both for investors and issuers – to buttress the market. Some issuers are failing to adequately disclose metrics for investors to gauge the success of an issuers' sustainability initiatives. These concerns encapsulate both individual issues and the sustainable practices of an issuer more broadly.
However, active managers possess the ability to discern which issues stretch the definition of 'sustainable' and an issuer's green credentials. At TwentyFour, we assess issuers on a case-by-case basis, and the ability to conduct fundamental analysis is a powerful tool to draw upon.
The inaugural green bond from the Oil and Gas sector, issued by the Spanish energy major, Repsol, is one example of the importance fundamental analysis is to ascertain the exact use of proceeds of an ostensibly sustainable issue.
At first sight, the issue fulfilled the attributes expected of a green bond; transparency, external review and the goal of helping Repsol transition to a greener future by reducing its carbon emissions by almost 60%. However, closer inspection revealed to us that rather than investing in green technology, the proceeds were being directed to extending the life of carbon intensive assets and improving their efficiency, increasing emissions in absolute terms.
The ambiguity surrounding green bonds stems from the fact that, ultimately, issuers may self-certify their debt as green. However, our experience with Bank of Ireland is one of many which neatly demonstrates how proactive engagement can unearth the green credentials of issues which at first glance invite some scepticism. After engaging with Bank of Ireland, we discovered the proceeds of its ‘green’ ABS issue were earmarked to solely fund incentives for homeowners to make environmental improvements. Comfortingly, this purpose contrasts with other, ostensibly ‘green’ commercial loans, which merely provide businesses with cheaper capital without overtly improving a borrower’s overall sustainability.
2. Engage with investors to provide visibility
One constant complaint from fixed income investors is about the lack of consistent data disclosure from bond issuers across sectors, particularly if that issuing entity is not a listed equity. While data providers have made some inroads into closing gaps, assessing the suitability of issues remains a sometimes onerous burden for bond buyers.
Primarily, we believe the issue is caused by a lack of standardisation in disclosures, limiting an investor's visibility into both the issuer's sustainable credentials and how the proceeds of any issue can be used. This lack of consistency partly reflects the disparate nature of issues that fall under the rubric of 'sustainable’ but which aren't directly comparable. For example, greenhouse emissions and gender diversity are both important ESG metrics but represent distinct domains.
Admittedly, the somewhat balkanised content of survey requests can lead to issuer confusion. With multiple channels seeking different answers, much of the available information is a patchwork, and the inconsistent nature of final data can often deter would-be investors.
One resolution could be for regulators to agree to minimum disclosure standards. While progress continues on that front, it is far from complete, and it is worth noting that standardised disclosure requirements carry the risk of overburdening smaller issuers.
As an alternative, proactive engagement from issuers to better understand investor requirements may allow them to better shape disclosures from the outset and provide more meaningful information to bondholders. The overall effect would hopefully go some way to closing information gaps and providing greater coherence for investors.
3. Face forwards, not backwards
One important way issuers can help satisfy fixed income investors' sustainability criteria is to provide improved insights into the trends underpinning their ESG practices. At times we find current ESG ratings are overly influenced by retroactive factors. Often, they are based on backwards-looking disclosures and paint a picture of an issuer's ESG credentials for a specific point in time. As a result, accurately evaluating an issuer's progress on sustainability is fraught with difficulty, and a lack of evidence could deter would-be investors from holding a firm's issues.
For fixed income investors, evidence of an issuer's improvement over time is often more compelling than retrospective vignettes. In fact, because most issuers will typically come to the bond markets multiple times we believe bond investors can have the biggest impact by supporting those companies that exhibit positive ‘momentum’ in their ESG performance. Accordingly, what investors require from issuers are concrete commitments and targets to evidence progress and their conviction to improve practices.
SSE, the UK energy company, serves as an example of the benefit of focusing on forward-looking commitments. Despite operating in a carbon intensive sector, SSE’s aggressive transition away from coal toward a largely renewable generating profile, supported by less-carbon intensive gas, and provision of concrete decarbonisation targets, in our view merits SSE’s inclusion in a sustainable fund whereas others may automatically exclude based on their outright ESG numbers.
As asset managers and bond issuers continue to grapple with rapidly increasing demand for ESG investing, we hope the above tips and examples will prove enlightening for both. While there are significant challenges posed by ESG data in the bond market – particularly when compared with its relative availability in publicly-listed equities – they are not insurmountable, and we feel active managers especially have a key role to play in engaging with issuers on the data they need.
Ultimately, we believe the discrepancies in ESG data within fixed income can only be overcome by proactive engagement between issuers and investors.
The discussion of any investments in this paper is for illustrative purposes only and were selected based on topics related to our ESG research. There is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The reader should not assume that an investment identified was or will be profitable.