ESG Club feature – Sustainable debt


These include promoting decarbonisation and temperature- alignment pathways, while exclusions form a big part of how asset managers approach climate risk on the debt side. “The other big tool, which is less appreciated, is engagement,” Lawrence says. “It’s important that we are engaging with com- panies in our debt portfolios to understand if they have a meaningful climate transition strategy in place.”


Not what it says on the tin But debt which is labelled sustainable is not an end in itself. “We shouldn’t just look at a portfolio of sustainable debt and believe it is robust from a climate transition perspective,” Lawrence says.


“What it does is signpost that issuers are potentially moving in a certain direction, but we need to look at issuers in their entirety and not just their labelled debt,” he adds. A portfolio of labelled debt cannot achieve net zero, Freedman says. “Labelled bonds, while an important and growing part of sustainable finance, must be considered on a case-by-case basis given greenwashing risks,” he adds. “They may not always provide credible and robust initiatives and targets.” Many labelled bonds make furthering environmental objec- tives part of their framework, but other targets exist too, such as healthcare provision. “There is much more that needs to be done in order to try and achieve net zero, and shorter-term tar- gets will be an important part of that,” Freedman says. Yet just because a company has not issued any green bonds does not mean it isn’t mobilising capital into green projects. “That would be more important to consider than a brown issuer who uses a green bond to fund a small amount of capex,” Lawrence says.


In the conventional debt market, engagement sets the expecta- tions for companies in terms of their strategy and making sure robust governance and accountability is in place. “That’s more important than the label on the bond,” Lawrence says.


Different shades of green But could a portfolio of sustainably labelled debt make an investor appear to be greener than they actually are? “That’s definitely a risk,” Lawrence says. “The tension in the market has always been around governance and whether or not the barriers to entry should be higher to issue sustainably labelled debt without hindering efforts to mobilise capital towards green activities. “LGIM’s position has always been to focus the analysis at the issuer, not just the instrument, to make sure the bond, and the portfolio, reflect a genuine move towards the transition and not just a chance for greenwashing,” he adds. Freedman says that it is “likely” sustainable labels make port- folios appear greener than they truly are, and warns: “You need


34 | portfolio institutional | October 2023 | Issue 127


We need to be careful about label chasing.


Scott Freedman, Newton Investment Management


to analyse issuers on a case-by-case basis,” he adds. “We need to be careful about label chasing.” With a limited supply of green bonds, the main option for institutional investors is to make mainstream debt more sus- tainable. “Issuers, both sovereign and corporate, are under much greater scrutiny in terms of behaving as responsible cit- izens,” Freedman says. “This raises the level of granularity around sustainability initiatives that a broad range of stake- holders, including bond investors, expect to see. “This introduces a greater level of accountability, a type of trust or covenant in place between issuers and investors. In turn, this leads to greater bondholder engagement, ESG analysis, tracking of ESG performance and will increasingly impact issuers’ cost of capital, especially for ‘sin’ sectors,” he adds.


A test of quality Transparency on non-financial factors by issuers varies, Freed- man says. “As you would expect, there is a greater level of dis- closure by listed companies and those in jurisdictions with stricter regulatory regimes. “We also see pressure on asset managers to make disclosures that are not always being provided by underlying issuers in portfolios,” he adds. Transparency on ESG performance is improving thanks to a “huge wave” of regulation, Lawrence says. “But we still have an issue with the consistency of reporting and the end-use case for the investor. “Again, I would tie that back into the case for engagement where we need to understand the nuance and context of the business model and how a company plans to become more sustainable.


“Disclosure is necessary, but being an end in itself is not suffi- cient,” he adds.


An independent view With the standard of disclosure needing to improve, it was dis- appointing to hear in August that S&P would no longer report


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