ESG Club


HOW FIXED INCOME CAN HELP DELIVER NET ZERO


Scott Freedman is a fixed income portfolio manager at Newton Investment Management


Estimates for the spending required if we are to achieve net-zero carbon emissions range from the low to high single-digit trillion dollars per year; to provide some context on the scale of the challenge, the world’s 2,000 largest non-financial com- panies are expected to have paid $3.7trn (£2.7trn) in 2021 on business-as-usual capital expenditure alone.


Whichever way you cut it, a huge amount of additional capital needs to be funded, and global debt-to-GDP is only going to increase further as a result. However, it is cheaper to act now than to have to deal with the consequences of inaction later.


Stranded assets We believe the next step will be the further internalising of ‘externalities’: companies will have to pay a price for carbon emis- sions – a cost which society bears today. This has material implications, in that the acceleration of cost pressures for higher emitters will increase credit risk, thereby limiting access to capital that can be acquired at attractive interest rates. As cli- mate regulations increase, we may see more stranded


assets, while business


models and carbon-intensive companies are likely to see steeper credit curves (high- er spread compensation for debt with longer maturity). This will also be the case for countries too, with sovereign credit risk an important consideration when seeking access to markets for funding. Most of this funding is expected to be financed by debt from governments, international development agencies and companies, rather than via equity, and we


expect fixed income’s role in funding the energy transition to become ever more critical. We expect it increasingly to come through ‘labelled’ bonds (bonds with spe- cific ESG or sustainability objectives), such as green, social, sustainable and sus- tainability-linked bonds, as well as through conventional or ‘vanilla’ bonds. Private capital will be key as government balance sheets will struggle to sustain the level of investment required, which will be needed for all sectors and countries – not just the most carbon- intensive ones. Big central-bank stimulus programmes are already in place, but we believe these are just the start. Sustainable finance has been growing quickly, but it is still small, and much more will be required to achieve net zero. Take the labelled-bond market, for example; although it has $1.5trn (£1.1trn) in outstanding issuance, this only represents 1.2% of the global bond market.


Increasing accountability


Over the next few years, there will be less need for bond issuance to be in labelled- bond form. The increasing accountability of


all stakeholders, including govern-


ments, companies, investors and asset owners, should mean less need for labels but more emphasis on differences in the cost of capital between issuers. While investors must be on their guard against the threat of ‘greenwashing’ or overstating the environmental impact of products, we believe this growth in demand for labelled-bond issuance and other sustainable fixed-income assets will continue to gather pace. Our view is that thorough due diligence and careful con- tinuing analysis of ESG factors for issuers from a holistic perspective, rather than a single project and asset focus, can help


PI Partnership – Newton Investment Management


investors avoid greenwashing pitfalls. And it is not just investors putting pres- sure on companies; net-zero policy is driving banks to expect clients to demon- strate a credible carbon-reduction plan as part of the ‘greening’ of their loan books. While the wider backdrop of monetary and fiscal policy will be important given the likely increasing quantum of debt, we believe central banks and fixed-income investors can and will play an increasing- ly pivotal role in directing capital to pro- jects that can help move the planet to a more equitable, lower-carbon way of life.


Need for a just transition To avoid a proliferation of different stand- ards, it will be important to encourage cohesive regulation to enhance the role of the financial system, and the private sec- tor needs to have rigid frameworks in place to provide confidence around poten- tial returns on capital. Finally, we must remember that there are social consequences to funding the cli- mate transition, such as a change in the profile of skills demanded from the work- force, so green targets should not be con- sidered in isolation, without a view on realising a just transition. Public finance needs to align with climate goals and eco- nomic development objectives; main- stream capital also needs to be mobilised alongside green capital.


The shape of fixed-income markets is changing; we expect to see a future in which they play an increasingly important role in servicing society in positive ways.


Important information This is a financial promotion. These opinions should not be construed as investment or other advice and are subject to change. This material is for information purposes only. This material is for professional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell investments in those securities, countries or sectors. Newton manages a variety of investment strategies. Whether and how ESG considerations are assessed or integrated into Newton’s strategies depends on the asset classes and/or the particular strategy involved, as well as the research and investment approach of each Newton firm. ESG may not be considered for each individual investment and, where ESG is considered, other attributes of an investment may outweigh ESG considerations when making investment decisions. Issued by Newton Investment Management Ltd. ‘Newton’ and/or ‘Newton Investment Management’ is a corporate brand which refers to the following group of affiliated companies: Newton Investment Management Limited (NIM) and Newton Investment Management North America LLC (NIMNA). NIMNA was established in 2021 and is comprised of the equity and multi-asset teams from an affiliate, Mellon Investments Corporation. In the United Kingdom, NIM is authorised and regulated by the Financial Conduct Authority (‘FCA’), 12 Endeavour Square, London, E20 1JN, in the conduct of investment business. Registered in England no. 1371973. NIM and NIMNA are both registered as investment advisors with the Securities & Exchange Commission (‘SEC’) to offer investment advisory services in the United States. NIM’s investment business in the United States is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Both firms are indirect subsidiaries of The Bank of New York Mellon Corporation (‘BNY Mellon’).


Issue 111 | March 2022 | portfolio institutional | 29


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