03.06.2020
By Shanny Basar

ESG Impacts Sovereign Credit Spreads

Sovereign environmental, social and governance scores have a greater impact on credit default swap spreads in developed, rather than emerging, markets.

US asset manager Federated Hermes and Beyond Ratings, the fixed income ESG data provider, analysed five-year CDS spreads and ESG scores from 28 developed market and 31 emerging market countries between 2009 and 2018.

The study, Pricing ESG risk in sovereign credit, part II, showed there was a significant relationship between ESG scores and sovereign CDS with a stronger relationship in developed markets.

A study last year by Federated Hermes and Beyond Ratings found that, on average, the countries the highest ESG scores have the tightest CDS spreads, and vice versa. The new research investigated which countries are driving this relationship.

Mitch Reznick, Federated Hermes

Mitch Reznick, head of credit research and sustainable fixed income, at the international business of Federated Hermes, said in a statement: “We believe that the less pronounced, but still existing relationship for emerging markets, implies that the relative financial weakness of some emerging markets leaves them more vulnerable to deteriorating ESG factors, which translates directly into credit risk. Our results suggest that movements on CDS spreads for emerging markets were related more to other country-specific factors that our model does not consider.”

Dr. Michael Viehs, head of ESG integration, at the international business of Federated Hermes, continued in a statement that the research has important implications for other debt instruments, such as money market securities.

“The research will help our credit team make better investment decisions and help them price ESG risks with greater precision,” added Viehs.

Investment grade bond performance

ESG investing is also source of outperformance for investment grade bonds from European issuers, but the opposite for American issuers, according to recent research from Amundi Asset Management.

Amundi said in a report: “We observe that ESG has had a more positive impact on euro investment grade bonds in recent years than on the US dollar investment grade and high-yield investment universes. Nevertheless, we observe a common trend that ESG is increasingly integrated into the pricing of corporate bonds and is a concern when building an investment portfolio.”

The European asset manager had previously analysed the link between equities and ESG and found that it was source of outperformance from 2014 onwards.

Alban de Faÿ, head of socially responsible investment fixed income processes at Amundi , said in a statement: “Contrary to common ideas, ESG investing may generate performance in euro investment grade bonds. In the case of US dollar investment grade bonds, ESG investing is penalized. But we are beginning to see the light, as the cost of ESG investing has been dramatically reduced these recent years.”

Climate-related disclosure

Regulators want companies to improve their climate-related disclosure and the UK Financial Conduct Authority has today published proposed requirements for premium listed issuers.

The new rule proposes that all commercial companies with a premium listing to explain if their disclosures do not meet the approach set out by the Taskforce on Climate-related Financial Disclosures, a set of existing global standards. The consultation period closes on 5 June 2020.

Andrew Bailey, FCA

Andrew Bailey, FCA

Andrew Bailey, chief executive, said in a statement: “Improved disclosures will support better asset pricing and enable investors to make more informed choices about where to allocate their capital – which will ultimately support the transition to a low carbon economy.”

The Climate Financial Risk Forum will also soon publish industry guidance, covering climate-related disclosures, risk management, scenario analysis and innovation. The forum is an industry group that the FCA launched jointly with the Bank of England’s Prudential Regulation Authority in March last year.

The FCA is also currently considering how to enhance climate-related disclosures by regulated firms, including asset managers and life insurers, to ensure a co-ordinated approach.

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