Last year global sustainable debt issuance hit a record of over $1.4tn, with the overall sustainable debt universe expanding to near $3.4tn. In the first quarter of 2022 this healthy trend halted temporarily, as high energy prices and rising borrowing costs weighed on market trends. We believe this setback should prove transitory and that the sustainable debt market remains on track to exceed $4tn by mid-2022, as the Russia- Ukraine war should reinforce the trend towards sustainable investing. We believe the current geopolitical tensions could be a catalyst for political will to step up the Net Zero transition, as reducing the dependence on fossil fuels may emerge as a national security priority in support of energy independence in some jurisdictions.
This evolution will bear important consequences for ESG fixed-income investing as a whole, even if in this article we focus mainly on credit markets. While early bird institutional investors started to incorporate ESG criteria in their portfolios some years ago, the trend intensified in 2021 with the Covid-19 crisis and the introduction of the new Sustainable Finance Disclosure (SFDR) regulations in Europe which encourage investors to opt for more ESG transparency. Nowadays, the most common ESG integration policy in fixedincome portfolios has evolved from an exclusion-only policy to a more articulated set-up, which combines an exclusion policy with some form of quantitative ESG scoring (ESG is going mainstream). We think that investors should go beyond this quantitative approach and apply materiality as a way to reconcile quantitative scoring with qualitative credit assessments for effective and well-rounded ESG portfolio integration. This will help identify short- and long-term risks to prevent any security impairment, while pursuing relative-value opportunities.
This approach should be complemented with an effective engagement policy between issuers and investors. If applied on an ongoing basis this could encourage companies to adopt best ESG practices, while challenging them on the ESG risks they may face. In addition, ESG reporting between investors and final clients is key, and part of our duty, as it showcases the investor’s commitment and facilitates opportunities for dialogue with clients on an ongoing basis.
Some specific considerations need to be applied when dealing with securitised assets, due to their specific nature. Here, the debate focuses on whether it is more appropriate to consider the compliance of the pool of assets or to assess ESG compliance at the originator level, considering its ESG policies and the use of proceeds obtained from the sale of loans. Focusing ESG analysis on the collateral may leave holes in the risk detection and magnify ESG risks in the balance sheets of entities holding the worst assets. In the end, it may paradoxically prevent the development of these virtuous assets. As such, it needs to be complemented with an ESG assessment of the originator.
In summary, we believe that the journey of ESG integration into fixed income portfolios has been a long one, but much remains to be done. Large institutional asset managers could play a key role in facilitating the integration of ESG principles into fixed-income investment processes. The next steps include the extension of ESG integration to other fixed income assets and to non-traditional issuers, further development of labelisation and being active regarding the Net Zero goal.