Emblematic of how rapidly information is coming on ESG these days: after I published Part 1 of my series exploring who is the primary beneficiary of corporate ESG programs, a handful of articles appeared that are meaningful, relevant and compelling enough to bring forth.
Bond Issuer Ratings
The Financial Times reported an interesting development from the Asian Infrastructure Investment Bank (AIIB) in the sustainability/green bond market: rather than rating a project’s sustainability/green attributes, AIIB has proposed rating the bond issuer’s own ESG credentials as an institution which can then be applied to all instruments issued by the firm. According to Domenico Nardelli, AIIB’s treasurer:
“We said: ‘Maybe we can see if we can remove some of the uncertainty and really place the issuer — AIIB — in the market as a sustainable issuer’ . . . If you are a potential investor in a bond issued by AIIB, you don’t have to worry about which of our bonds you are going to buy,”
This approach certainly has some merit, but it may leave out project-level specifics that should be made transparent to investors and subjected to internal controls/monitoring critical to achieving goals/meeting covenants of individual projects.
On the Question of ESG Outperformance in Equities
My original blog mentioned a new paper from research firm Scientific Beta questioning the idea that ESG performance creates additional stock returns. In my piece, I pointed out that the paper itself was criticized for not being peer reviewed prior to publication. In an ironic twist, London Business School Professor of Finance Alex Edmans points out that some of the studies criticized by Scientific Beta are themselves not peer reviewed and contain flaws and the company was correct to question them:
Scientific Beta is right that claims of outperformance must control for other factors, and be based on long time horizons. Indeed, this is the role of academic peer review — no top journal should publish a study that failed to do this. In contrast, the papers that Scientific Beta correctly criticises are either unpublished, or in practitioner outlets. However, given confirmation bias — the temptation to believe even flimsy evidence if it supports your preferred viewpoint — many people latched on to these studies, despite their basic errors.
Alex’s more fully developed article on the matter is very much worth a read.
Perhaps Scientific Beta is taking a cue from Hamlet: Whether ’tis nobler in the mind to suffer the slings and arrows of outrageous fortune, or to take arms against a sea of troubles, and by opposing end them?
Bonds and “Transition Washing”
One green bond category is the “transition bond” – intended to help carbon-intensive companies fund investments in reducing their carbon emissions towards a greener future. While there has been much talk about “transition” recently, transition bonds are effectively non-existent. According to S&P Global, only $5.7 billion in transition bonds have been issued since 2017. Bloomberg pointed out:
Some of these transactions have been criticized for lacking “the ambition asked of transition bonds.” S&P sustainable finance analyst Lori Shapiro said some market watchers are assailing these deals for not being aligned with the goals of the Paris Agreement… While sales of transition bonds have been slow this year, the issuance of sustainability-linked bonds with climate-transition targets has been increasing. More than 70% of the $15 billion of sustainability-linked bonds sold this year include climate targets, according to the ICMA.
In my opinion, these developments show that investors clearly benefit from ESG initiatives in various ways, including through the introduction of new products. At the same time, questions may be raised about the green credentials of some of these products. Moreover, debate continues about the linkage of ESG performance to equity pricing.
The question of whether investors are the primary beneficiary of ESG remains open.