Sustainable debt – ESG Club feature
ESG scores alongside its credit ratings. Could this be a sign of how hard it remains to prove that investors cash is making a positive difference? “I don’t think so,” Lawrence says. “That probably represents more of a misunderstanding of what ESG ratings are there to do.
“In the case of S&P, they are a credit rating agency and their decision to remove the ratings reflects their ability to trans- late ESG data into a material credit rating impact. “What they have done is kept their qualitative analysis in terms of explaining where ESG risks could potentially impact the rating.”
The bigger challenge is people’s understanding of what ESG ratings are, how they’re constructed and how to use them. For Lawrence, ESG ratings are a subjective analysis of how compa- nies are managing sustainability risks and opportunities. “But where these ratings become hardwired into portfolios, then we need to take care with how the rating has been constructed, what is the methodology.”
While such data can be useful, perhaps this is a positive move, in that the lack of consensus among providers could be confus- ing. Freedman says that such divergence among ESG rating providers mean that you cannot take such ratings seriously. “It is just part of the mosaic of information. “We do not rely on data providers’ methodology but on raw data, and then draw our own conclusions,” he adds. “The unfortunate thing about a conventional credit rating agency no longer reporting ESG scores alongside its debt rat- ings is the message this gives to issuers,” Freedman says. “Having that data published increases the level of scrutiny and accountability on issuers – and having a more explicit link between ESG factors and a conventional-credit rating does impact market pricing, thereby encouraging issuers to strive to be an ESG leader if it results in a possible lower cost of capital.”
Different worlds For investors with sustainable goals, their debt portfolios must reflect them, matter who they are lending to. This includes cor- porates
or sovereigns, which have similarities but offer
investors different exposures. First of all, the number of sovereigns is fixed, unlike in the cor- porate world, which is constantly changing. “We have a lot more information about the world’s sovereigns and there’s lots of ESG data that has existed for a long time. In a sense, meas- uring ESG risk for sovereigns is easier than for corporates,” Lawrence says.
“Where it gets trickier for investors is on the engagement side. As a significant holder of sovereign debt, we are an important stakeholder to governments. We can therefore use this leverage to influence policymakers to address ESG risks and opportunities. However, there are challenges which can limit our influence, including structural features of the sov- ereign debt market.”
And investors need to have influence over governments if they are using their money. “There are challenges and barriers that we need to overcome in the sovereign market with respect to what sovereigns are doing on the ESG side,” Lawrence says.
Disclosure is necessary, but being an end in itself is not sufficient.
Jonathan Lawrence, Legal & General Investment Management
Behind the rate Have rising interest rates had an impact on the sustainable terms of debt? “Not really. Issuance looks quite robust,” Law- rence says. In September, labelled debt on the active side of LGIM’s invest- ment universe was about 8% of the index. In 2020, it was around 2% to 3%. “When issuers come to market, we are see- ing a lot of momentum behind the labels. So, the macro con- ditions could play through in terms of issuance trends in general,” Lawrence says. “But we are seeing a lot of appetite to use the labels on bonds, and increasingly, a greater breadth of issuers are coming to market with this form of debt.” However, Freedman says the volatility in the bond market resulting from the fast pace of rate hikes by central banks has led to a slower pace of sustainable and broader bond issuance. “As we have seen lately, there is a gradual realisation amongst companies and governments that decarbonisation ambitions are important but not at any cost,” Freedman says. “We are see- ing timeframes therefore extend and policy-backtrack from governments. The cost of achieving the transition has been increasing not only due to higher funding costs from higher rates, but also from persistently higher inflation. Within this is more acceptance of the need for climate adaptation as well as mitigation.” When it comes to lending your capital to corporates or govern- ments, the important point is that it is not about where they are today, but where the capital they receive will take them.
Issue 127 | October 2023 | portfolio institutional | 35
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