Newsletter: ESG and Bonds

February 11, 2022

Newsletter: ESG and Bonds

ESG factors can help explain downgrades.

Hello from Impact Delta.

Enjoy our periodic newsletter, containing insights and news related to ESG and impact investing. In this edition, we look at the latest research on how ESG factors are affecting pricing and returns of bonds, ratings and real estate.

ESG is getting material -The adoption of ESG factors by investors has increasingly been influenced by the material impact it can have on financial performance. Adding further credence to this movement, a recent study found that bonds earmarked for a 'potential credit rating downgrade' because of environmental, social or governance (ESG) concerns were more than twice as likely to be downgraded during 2021 than bonds red-flagged for other reasons. 

But positive ESG ratings do not mean carbon free – With ESG factors increasingly affecting ratings more broadly, the exposure to carbon and fossil fuels is becoming one of the negative factors that can depress a rating. And yet, several of the largest banks received ESG upgrades, despite tens of billions of loans to oil and gas companies. JP Morgan was upgraded for ESG reasons, having underwritten the largest volume of 'green bonds' compared to their peers. And yet, the bank is also the largest lender to oil and gas companies since the Paris Accord was signed in 2015. The justification is that oil and gas lending as a percentage of the total loan portfolio determines the 'green' score, which basically means smaller banks can't lend to fossil fuel companies and keep their rating, while larger banks can.  

ESG factors affect sustainability bond performance – A Morgan Stanley study of ESG bond pricing found that bonds with more rigorous sustainability targets and substantive penalties for non-attainment typically had superior price performance for the first 30 days after an offering. Conversely, less stringent criteria typically underperformed.  After 30 days, gains were less correlated with rigorously assessed sustainability features of the bond, suggesting primary issuance investors are increasingly taking ESG seriously. 

Green real estate also starts to see a 'green premium' – Over the last several years, opinion has been divided as to whether ESG factors affect the pricing of real estate. Perhaps putting this debate to rest, Cushman and Wakefield evaluated the premium that LEED buildings commanded, holding other factors constant (urban/suburban, asset age, size, etc.). The data indicated that these buildings commanded a 25% premium per square foot on average. 

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About Impact Delta

A secular shift towards a more responsible capitalism is underway. Impact Delta is a specialist consultancy founded to help investment firms capitalize on this shift. We believe good environmental and social thinking helps investment firms raise capital and earn better returns. More about us here.

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