Environmental, social and governance considerations have become part of the structured credit investment landscape for institutions.
In light of this, Fitch Ratings has launched a new research product, ESG Relevance Score. The product is aimed at all types of global structured credit finance for which the ratings agency provides analysis. These comprise international-scale asset-backed securities, commercial mortgage-backed securities, residential mortgage-based securitisation transactions, and international-scale covered bond programmes.
The agency has excluded the following from the scope of the new product: collateralised loan obligations, broadly syndicated loans, mid-market loans, some types of structured finance collateralised debt obligations, and insurance-linked securities. It is understood that this decision was based on differences in key inputs – mainly the historical performance of underlying collateral, as well as the tenor of credit transactions – that drive the agency’s ratings of structured credit products.
Hermes Investment Management is among the credit investment managers that have been active in implementing ESG frameworks. The London-headquartered firm has developed a model to price ESG risks into credit instruments. It uses the spread of credit default swaps as a proxy for credit risk, as well as a proprietary-sourced numeric value, QESG, which represents ESG risks.
A report by Mitch Reznick, CFA, a head of sustainable fixed income, and Michael Viehs, an associate director for ESG integration at the firm’s responsibility office, observed that the credit spreads of debt instruments had widened sharply as ESG policies and practices worsened.
Andrew Lennox, a London-based ABS portfolio manager at the firm, said lenders should not be less focused on ESG considerations just because the loan tenor to which they were exposed was shorter. He added that the time exposure should not be factored into ESG considerations because short-term loans could be re-financed by the same lenders.
Stephan Michel, a London-based senior fixed-income portfolio manager at Hermes, also pointed to the “disappointing” approach to ESG considerations that he has seen in the industry. “Some managers argue the behaviour of this borrower is not great, but my exposure is limited in time, therefore, it won’t harm me,” he told PDI. He added that asset managers sometimes say they are considering ESG implementation just because it is topical and can help them from a marketing perspective.
An industry source told PDI that reputational concerns were a greater priority than ESG risks for commercial banks and securities firms when they are selecting deals and executing transactions.
“It is more the LPs that require ESG frameworks rather than GPs,” the source said. “It will cost a lot for a sponsor to implement, for instance, environmental safety measurements. It is additional capital expenditure that you are asking for.”
ESG considerations for large-cap fixed-income investors, especially those from Japan, have been mounting in recent years. This has prompted their investment managers to launch ESG-relevant products. It has also led industry observers to initiate new research programmes.
According to a report from Japanese firm TD Holdings, there were a total of 41 Japanese life insurance companies as of April 2018. According to reporting by Reuters, these insurers collectively held around ¥370 trillion ($3.4 trillion; €3.1 trillion) of assets under management as of October 2018.
The latest signatory directory for the UN Principles for Responsible Investment, published earlier this month, showed that at least 11 Japanese life insurance groups – including the asset management subsidiaries of two insurance groups – had signed up to the principles.
Dai-ichi Life Insurance Company and Nippon Life Insurance Company are among the institutions that have listed ESG considerations as part of their strategic priorities, according to mid-term plans that they aim to achieve by 2020 and 2021 respectively.