ESG Matters in Fixed Income

Terry Flanagan

Fixed income investors are becoming more aware of environmental, social and governance (ESG) issues through the prisms of the companies backing the bonds and the intended use(s) of the capital raised.

“Bond investors who are interested in an ESG tilt to their portfolios are looking at both sides of the credit equation,” said Gregg Sgambati, managing director of S-Network ESG Solutions. “They’re looking at issuers to see if they are ESG-aware and at the use of proceeds.”

Issuers have been evaluated along some ESG criteria for a long time. “Ratings agencies, in determining the creditworthiness of an issuer, have looked at some ESG issues,” said Sgambati. “They have not labeled them ESG, and they’ve focused predominantly on the ‘G’ pillar when examining corporations for creditworthiness. Ratings agencies have associated corporate governance with a strong indication of creditworthiness concluding that companies that aren’t governed well could be a credit risk.”

Governance deals with issues from board diversity to board structure in public companies. “Governance covers issues ranging from board structure, functions, and diversity to executive compensation and shareholder rights in public companies. For example, the way corporations are chartered and whether or not their by-laws have anti-takeover provisions which are unfavorable to investors,” said Sgambati.

As for the use of proceeds, “new bonds are being designed so that the proceeds must have an impact on the environment,” Sgambati said. “These are called green bonds and are crafted so that the proceeds must be used for green projects, or projects that are tied to making an impact on the environment in some positive way.”

A group of banks, in concert with an NGO called Ceres, have created “green bonds principles and those principles provide guidelines for these bonds to raise money for either existing or new environmental projects,” Sgambati said. “That means that ESG investors can have a reason for for buying a bond over and above just selecting the highest ESG-rated issuer.”

S-Network ESG Solutions, in conjunction with Thomson Reuters, has created a family of ESG ratings and indexes called the Thomson Reuters Corporate Responsibility Ratings and Indexes.

“It’s an ESG rating scheme that rates over 4,600 companies on environmental, social, and governance metrics,” said Sgambati. “Each of the companies has four ratings: an environmental rating, a social rating, a governance rating, and an ESG composite rating, and all of the ratings range from 0 to 100, and are designed so that you can compare companies across regions and industries.”

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