ESG Club


CLOSING THE ESG GAP IN ASSET-BACKED SECURITIES


Despite its position as a public asset class with more than €400bn (£333bn) of out- standing issuance in Europe, third-party ESG coverage of asset-backed securities is sparse. What opportunity does this offer asset managers who do mind the ESG gap in this asset class?


ESG investment analysis has rapidly


transformed in recent years, as investors and regulators have recognised the importance of these considerations for potentially generating sustainable, long- term investment returns. Within traditional asset classes, this has led to a proliferation of third-party research from ratings providers, such as MSCI and Sustainalytics, which apply standardised, quantitatively driven ESG scoring systems to hundreds of thousands of securities. Regulators have also begun to implement formalised, far-reaching ESG policies, such as the European Union’s Sustainable Finance Action Plan (SFAP), while in the UK, the Financial Stability Board’s Task Force on Climate-Related Financial Dis- closures (TCFD) is expected to introduce similarly robust ESG-related disclosure requirements. In non-traditional asset classes, however, the development of standardised frame- works around qualitative and quantitative considerations has proven more challeng- ing due to the additional complexity of the securities involved. This includes asset- backed securities (ABS), for which third- party ESG ratings providers offer limited coverage


and regulators provide no


specific guidance, despite ABS being a public asset class with €400bn+ (£333bn) of outstanding issuance in Europe¹. We believe that this places a strong emphasis on asset managers to drive the industry forward in improving and standardising ESG analysis of ABS.


Why does ESG analysis of ABS differ from corporate bonds?


A significant obstacle to developing stand- 34 | portfolio institutional | February 2022 | issue 110 Source: M&G Investments, November 2021. For illustrative purposes only.


ardised ESG frameworks is the multi-lay- ered nature of securitisations. Whereas traditional corporate bond analysis pri- marily involves evaluating an issuer and its capital structure, the securitisation process involves several entities, which can include: – The originator – Sponsor – Servicer; and/or – Asset manager


This introduces various challenges from an ESG perspective. For instance, rather than investing or lending directly to a spe- cific company, an ABS transaction is likely to involve purchasing securities issued by a bankruptcy-remote special purpose vehi- cle (SPV), which has no board of directors or other employees. Meanwhile, the cor- porate entity that originated the assets


PI Partnership – M&G Investments


may not be involved in the transaction, or the deal may be backed by loans originat- ed by lenders that no longer exist. Due to these fundamental differences, we believe ESG analysis of ABS requires careful eval- uation of three core areas – the transac- tion, or deal structure; the underlying asset pool; and the counterparty.


Engagement is driving progress Issuers are making steady progress in dis- closing ESG-related information, with newer lenders leading the way. Recently, we were encouraged to see that an origi- nator with which we had previously worked closely (a UK challenger bank) had significantly increased its ESG disclo- sure in its latest residential mortgage- backed securities (RMBS) transaction. Notably, the bank disclosed information on how its lending practices and day-to- day operations are aligned with the 17 United Nations Sustainable Development Goals (UN SDGs), alongside details of its own carbon footprint, staff diversity and measures it takes to avoid predatory lending. Nevertheless, the securitisation industry still lags conventional fixed income mar-


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