ESG and sovereign debt – Roundtable
about are quite small. It might be a five to 10 basis points difference in yield. Whilst some clients might struggle with the notion that their returns are going to be lower by 10 basis points, it does not take much for there to be a realisation of ESG risk that affects the legacy bonds by at least that amount or more.
An interesting discussion we have had with clients on this is that we are talking about five or 10 basis points; if you get it wrong there it is not going to cost you too much either way. Everyone is comfortable and relaxed about that, but once you start looking at emerging markets, or the wider bond uni- verse, such as government debt in China, you could be exposing yourself to a differ- ent mix of ESG risks. You might be taking governance risk as opposed to climate risk, for example. Yet when you are making those compari- sons, the yield difference is much starker. So, if you are weighing up investing in an emerging market government bond that earns 1% to 2% more than what you would get on a green gilt, you are asking yourself if only buying the green gilt and forgoing the additional yield is a decision that has been made to ensure I am not exposed to ESG risk. To frame that question another way, is it our view that not buying those high yield- ing bonds will mean that the ESG risks will be realised and wipe out their addi- tional yield advantage. So, there are some challenging questions for investors to answer. We do not necessarily have a great frame- work to compare all these investments. If you are making decisions that have enor- mous fiduciary impacts, you need a framework to justify and validate your decisions. It is an enormous challenge that lies ahead of us.
Are you paying a premium for such debt, Adam?
Matthews: We did not buy the green gilt. The government had an advantage in
coming to market when it did as it pre- pares to host COP26, but how do we get to a point where this is mainstream not an add on project. We need tools that ena- ble us to understand what we can expect and to be more discerning in what we are willing to support.
Nuwan, would you be happy to pay a pre- mium to hold this debt? Goonetilleke: In some cases, we are. The question is: is it a premium or is the debt less risky? We have not landed on the answer. We are too early in on our jour- ney. That is something we need to land on to continue our participation.
Adam asked when ESG-complaint debt will become mainstream. What is needed to get it to a stage where every government bond makes a positive impact on the world? Ryan: One day we will get to a point where all bonds are ESG bonds. It will be consid- ered along the lines of tobacco or land mines in that investors will not want those risks in their portfolio. It will be the norm. One way of messaging that this transition needs to happen is to remind issuers and governments that ESG risks increase
their cost of debt. That is important and affects everything they do. The messaging also needs to include that there is a demand for green bonds, there is a market for them. From our perspec- tive, green bonds are in such high demand that investors buy and hold them, which creates a liquidity issue. So, we need more supply.
Another point is engaging with issuers. You are not directly engaging with gov- ernments; it is not the same as owning equity and being a shareholder. You do not have a direct channel with them. That means we need to be careful to make sure our clients voices are getting through to governments in the right way. Most of our clients are moving to a net-ze- ro position and there is a sense of urgency. They want us to pass that message on. So, it is important for us to get that right and help our governments understand that it needs to change. Matthews: I am excited by the opportunity for us to work on this issue in a way that perhaps we have not been able to do before. The collective knowledge, the wis- dom within individual funds is evidence, but at the same time we have reached a point where significant commitments are being made by funds on issues like cli- mate change.
Clients would like to achieve a good return on one hand and have full commitment to ESG on the other, but they do not always go together. Gerard van der Pol, Unilever
There is also regulatory pressure on funds in the UK to demonstrate that they have an approach that understands climate risk in all asset classes and that affords an opportunity for a different dialogue with countries.
I am excited by that opportunity. The tool is in development. I encourage everybody to ensure that this is what we need, that it is practical and we can have confidence in. There will be expertise within individ- ual funds to complement that, but we need that common lens on understand- ing the transition in this particular asset class.
There is a good chance for us to shape a different narrative here and work practi- cally. As a fund, we are energised by this.
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