GEFI Round Table Discusses Ethical Finance Approaches in the Debt Capital Markets
The Ethical Finance Roundtable was held on Feb 27th at Baillie Gifford in Edinburgh. Entitled "Ethical Finance Approaches in the Debt Capital Markets", the round table covered market developments in the $1.45 trn climate-aligned bonds market (such as green bonds) along with innovative trends in ESG and SDG bonds.
Following a welcome by Chair Omar Shaikh, Graham Smith (Director - Sustainable Finance Unit - Global Banking, HSBC) provided an update on HSBC's strategy to deploy $100bn in sustainable financing and investment by 2025, and an overview of the bank's SDG bond and how it has integrated the Green Loan Principles and Green Bond Principles into its financial products and instruments:
The $100bn is typically deployed through: 1) bonds 2) loans and 3) investments where HSBC maintains a focus on returns. The green agenda is being driven by regulation where some governments are taking measures that encourage responsible lending in the private sector. The Paris Agreement, which set out national contribution guidelines in the form of NDCs, prompted legislation such as the Clean Air Act in the UK. Furthermore, in France, the Government issued Law 173 in making investors disclose green assets from brown banks are obliged to rebalance their assets with a higher ratio of green to brown.
HSBC is a leader in green finance and is committed to investing in green assets that drive the market forward. With the examples of Clean tech growing by 4% to 5% Graham suggested that investors should be interested in the space green or not.
In March 2018 the Green Loan Principles were published. Graham explained that this important development, with a similar rationale to the Green Bond Principles, applies to broader sections of business and society and has now become the “gold standard” for green loans. Banks can now offer products that they understand.
Graham explained the emergence of products (such as green, social, sustainability bonds and loans to transition loans) and that the Loan Association is likely to provide a much-needed definition for ESG loans in March this year.
With ESG products positioning businesses as good corporate citizens and green products highlighting a commitment to the environment there are PR benefits to be derived from businesses engaged in sustainable finance. In terms of pricing, there is no financial penalty for investing in green bonds but they still prove costly for issuers.
HSBC launched the world’s first bond that directly supports the SDGs and the Paris Agreement. The US$1 billion raised through the bond finances projects that benefit communities and the environment, including hospitals, schools, small-scale renewable power plants and public rail systems.
The key message is that regulations are driving the development of the market, leading to change at the commercial level. A prime example is the Task Force on Climate Related Financial Disclosure (TCFD).
Caspar Cook (Head of Analysis, Cameron Hume) then outlined Cameron Hume's client-led approach to ESG, which focuses on a combination of values-based and returns-based strategies, and how this has evolved to successfully grow the Global Fixed Income ESG Fund.
Cameron Hume, an active fixed income specialist, is a signatory to UN PRI. Caspar started by explaining the considerations of applying an ESG approach to fixed income, which differs from its integration into equity investments. There remains a lot of confusion as to the definition of ESG so Cameron Hume has divided its approaches into two categories: returns-driven (ESG factors that are material to performance) vs values-driven (implement ethical social and environmental objectives of different investors). Cameron Hume focuses on returns-driven investment and only practices values-driven investing in segregated accounts that mandate it.
Caspar believes that ESG is a good risk indicator and cited the example of PG&E, a prolific bond issuer known as the cleanest provider of energy in USA. Carbon conscious investors would have found this an interesting play but they filed for bankruptcy following their link to the California wild fires. ESG analysis, using MSCI, would have highlighted risks relating to its poor land use and diversification thereby discouraging investment.
A further example was shared by Caspar. Equifax, the biggest US credit scoring company, had a substantial data breach recently that severely impacted its shares and bonds. MSCI had ranked Equifax 1 out of 10 in data security and flagged this as a material risk. These factors do not typically appear in annual accounts or financial ratios that many investors focus on.
ESG factors help investors focus on neglected risk that leads to more sustainable long-term investing. Cameron Hume’s Global Fixed Income ESG Fund uses responsible investing to bring ESG factors in to the investment process tilted towards higher ESG rated companies.
Following the formal presentations a lively and lively question and answer session followed. Some of the key points raised included:
- It is easier to influence sovereigns through the bond markets than corporates.
- ESG policies in businesses tend to be top down and not always filtering to the bottom layer of people making decisions.
- ESG factors influence investment performance but not necessarily on a consistent basis. Some studies show that it can add 0.5% to 0.8% a year in performance. Participants were skeptical because it is hard to disentangle ESG from other factors.
- Clients have fiduciary duty towards performance so it is a challenge for fund managers to integrate a universally agreed ethical stance into a portfolio (e.g. Calpers divested from tobacco stocks 15 years ago and recently published that that decision cost them USD6bn).
- Even if findings suggest that ESG is good for performance over the last few years there is a lack of evidence indicating that it will improve performance going forward.
- The bond industry must evolve to ensure bonds fulfil their green promises. At the moment they just get declassified but there should be penalties. And declassification often takes place long after the bond has de-greened (e.g. Mexico City airport project).
The session concluded with a discussion on the role the debt capital market industry can play in driving standardisation in pricing, measuring and reporting. The key points raised were:
- At the moment the industry tends to tick boxes and gets PR recognition for this (e.g. the CDP used by the TCFD).
- There is no perfect measure for transition risk, which will play a key role in consolidating many sectors in the medium term.
- A nuance that influences the development of the industry positively is that asset managers pay for MSCI scorings while issuers pay for credit ratings.
- As investors increasing focus on analysing and challenging data a virtuous cycle will be created to drive up the availability and quality of data.
- A limitation on green bond reporting is the risk of breaching client confidentiality.
- The proof of concept is just as poor in green project proposals that are submitted for debt funding. This leads to a serious lack of viable sensible pipeline to invest in (especially in the SDG space). Large lenders end up majority invested in their own assets as a result (e.g. HSBC’s SDG Bond
