Sustainable investing is certainly the future of investing. According to S&P Global, 66% of the world’s biggest firms have at least one asset at high physical risk in the 2050 climate change scenario. So, how much has sustainable debt grown and how are investors adapting to the increasing importance of ESG metrics?
[soros]Q2 2021 hedge fund letters, conferences and more
Regulation, A Trigger
The main economic hubs of the globe are veering towards a whole set of regulations in favor of green liquidity.
On May 20, U.S. President Joe Biden signed an executive order that paves the way for clear climate-related financial risks disclosure. The order is set to “Make financial regulators analyze climate-related threats to the U.S. financial system.”
On the other side of the Atlantic, in July 2020, the EU had already issued the Taxonomy Regulation about the “overarching conditions that an economic activity has to meet to qualify as environmentally sustainable.”
But not only the regulation is prompting investors to look into ESG metrics. As commodities like oil have become more significant for macro hedge funds –due to inflation and market volatility– sustainability is more than ever a critical driver of every investment endeavor and macro risk assessment.
As asserted by the Hedge Funds in Q2 2021 report by HFM, “A key assessment for investors is how climate policies will interact with fiscal and monetary policies in filtering through the markets.”
The report further states that hydrocarbon-intensive businesses can anticipate reduced prospects from even the lightest ESG regulations.
Growth Beyond Estimates
Even before the issuing of U.S. and EU frames, the sustainable debt market had been growing at a great pace in terms of volume, scope, and popularity.
After three consecutive periods of decline, green bond volumes soared in the first half of 2019, hitting a record activity with $124 billion in issues. EMEA was the most active region by then, accounting for 47% of the total, followed by the U.S. with 30%.
The first half of 2019 was until then the busiest H1 for sustainable debt as a whole in most of its asset classes. By the end of the year, the $370 billion estimated was smashed when the issuing rose to $465 million.
In 2021, according to Reuters, sustainable debt sales more than doubled year-on-year in the first half with over $680 billion, “closing in on the $700 billion issued during the whole of last year.” The Institute of International Finance has estimated that global issuance by the end of this year will be a whopping $1 trillion.
“The issuance of bonds to raise money for climate-related or social projects, or linked to sustainability targets, is an increasingly popular option.”
IIF economist Khadija Mahmood told Reuters: “With Net Zero commitments in the spotlight, an acceleration in low-carbon energy investment and technological innovation has been supporting ESG securities issuance, along with strong investor appetite.”
How Firms Are Preparing
S&P Global says that investors are beginning to include ESG metrics within their investment mandates.
In a June 2020 survey by AtoZ Marketing Analysis and Kadence International, out of 728 fixed-income institutional investors, 77% reported taking into account the ESG characteristics of issuers and investments during the investment process.
For example, say S&P Global analysts, “investors may exclude investments that do not meet their ESG thresholds, arguably placing the burden of responsibility back on issuers.”
“While this is a key trend in the evolution of ESG investing, it may over time unintentionally reduce liquidity as identifying, evaluating, and assessing ESG themes becomes clearer.”
According to Steve Suryadinata of Mata Investments, issuers need to achieve an optimum balance between both financial and ESG metrics, to the point that the financial metrics “are not too affected or even better positively correlated.”
“Unfortunately such balance is hard to accomplish for many companies as it could affect their financial performance.”
Greenwashing Challenges
Mata Investments also asserts that “greenwashing” remains a challenge for many investors, as companies often phony up their ESG achievements. According to Steve Suryadinata, “Regulators in different parts of the world are working hard on this, with the EU’s Taxonomy for sustainable activities issued last year, and the U.K.’s ESG reporting being mandatory as of 2022.”
“In Asia, we see Singapore leading the way by pressing ahead with new regulations and guidance on ESG.”
The report Sustainability-Linked Bonds Offer Pricing Perk For Right Credits, published on May 27 by LCD, hints that “initial demand for sustainability-linked transactions in the European speculative-grade market could be 30%-40% greater than for conventional bonds.”
This is because investors with multiple funds are placing bigger orders, “rather than a higher number of orders.”
Still, several social and macroeconomic elements affect bond pricing, making it hard to single out the impact of ESG.
“Without placing too much weight on any specific data point, data from different corners of the market suggests that there may be a pricing advantage for issuers that pass investors’ ESG investment criteria,” states the report.
