US corporates are increasingly responding to bondholders’ demand to improve environmental, social and governance (ESG) standards as such issues become a bigger part of credit analysis.
Activist shareholders have long held sway among corporations, but creditors are also having their say in a market where highly leveraged issuers want to please bondholders focused on ESG issues in an effort to cut funding costs.
“If companies get a discount on their cost of capital because ESG investors find what they are doing attractive, they can get a better rate on their debt,” Doug Lopez, principal portfolio manager at Aristotle Credit Partners, told IFR.
“People underestimate the influence of a corporate bond investor.”
While Green and Social bonds have garnered outsized attention for specific company initiatives, the importance of tracking ESG metrics is playing a larger role in how investors and ratings agencies assess corporate balance sheets.
And this is already having an impact on the underlying credit quality of borrowers.
Over the past two years, 15% of S&P’s credit ratings moves - whether positive or negative - were at least in part the result of ESG-related risks, Mike Ferguson, S&P’s director of North America energy infrastructure and sustainable finance, told IFR.
The buyside community is also shifting from simply focusing on buying bonds to fund a Green project to taking a broader view by incorporating environmental and sustainability analytics alongside other metrics like leverage and interest coverage.
“We would rather see companies improve their full corporate wide ESG profile than spending too much time identifying a specific project that meets all the qualifications for it to be a green bond,” John Hoeppner, head of US stewardship and sustainable investments for Legal & General Investment Management America, told IFR.
“When we buy to hold until maturity, the ESG characteristics weigh much higher than if it was intended to be short term.”
Investors cited Dell International (rated BB+/BB+) as an example of a company that managed to garner strong demand on its bonds due to its focus on ESG issues. Order books swelled to US$11bn on its three-part US$4.5bn deal in March.
“It’s fair to say the larger investors have more clout in terms of raising ESG concerns because they have gotten more vocal,” Ferguson said.
A DATA-CENTRIC APPROACH
Three years ago, corporate management teams had little knowledge about ESG concerns but they have learned quickly and have become quite sophisticated in their analytical assessments, Hoeppner said.
There are a number of third party data providers, such as Sustainalytics, MSCI and IFR’s parent company Refinitiv that track ESG metrics and compile it into a score.
How ESG is measured varies across sectors. An oil company may be judged heavily on its environmental record and ability to prevent oil spills, while a textile company may be judged on the treatment of its workforce.
The rating agencies are boosting their involvement in this area as well.
S&P launched in April its ESG Evaluation benchmark that seeks to assign a single ESG score that is comparable across sectors and investment types, and just this week it began releasing ESG “report cards” for debt investors across specific sectors.
“Moody’s, Fitch and S&P are viewed as industry leaders and standard setters for credit ratings so as they evolve into ESG data providers they bring a level of rigor and credibility that will be helpful for expanding the market,” said Jed Lynch, head of social impact banking at Barclays.
For the last 10 years it was enough to just pick a “pre-packaged” third-party data provider, but increasingly investors are pulling from multiple sources to create internal ESG scores, Hoeppner said.
US markets still greatly lag Europe in the breadth of ESG integration, but the US is catching up.
“It could be the greatest company in the world, but if they have terrible behaviors around ESG, it’s probably not a good thing to be investing in, said Tom Murphy, senior portfolio manager at Columbia Threadneedle, said,
“That is not just from the standpoint of it being a bad financial return but it also leaves a bad taste in your mouth.”
