21 August 2019

The ESG data files - part four: fixed income data

While the availability of sustainability-related data for fixed income investments is catching up with that for equities, much progress remains to be made, Michael Hurley is told

The lack of reliable environmental, social and governance (ESG)-related data is often cited by investors as one of the main barriers to considering factors such as climate change in their investment strategies.

Criticisms include that the number of companies the data covers is limited, and that it is difficult to find enough forward-looking information.

These complaints are amplified in the fixed income arena, where investors can often feel that their specific requirements – including taking into account the varying degree of relevance of ESG risks according to the different durations of bonds – are unmet.

This is despite the fact that fixed income represents a significantly larger portion of global financial capital markets than equities.

To what extent is conventional ESG data fit for purpose for fixed income investors?

Carmen Nuzzo, senior consultant for the Principles for Responsible Investment (PRI), recently told Environmental Finance that the consideration of ESG factors in investment assessments started with equity investors, and "fixed income investors have been relatively late in considering these issues in their security evaluations".

Sarah Wilson, NuveenSarah Wilson, a senior director in $1 trillion asset manager Nuveen's responsible investing team, agrees: "Looking back, ESG data used to be limited only to public equities – we saw those issues analysed through the shareholder lens.

"But now we're seeing a big expansion of ESG data in fixed income, really evolving to focus on other portions of the economy. That can still be data relating to corporates, but also to government-related issuers, municipal bonds and the like.

"We're seeing the scope and nature of ESG change in reaction to investors' desire to apply these concepts to fixed income," Wilson adds. "And, as we're seeing increased coverage from the providers, there has been more new fixed income products."

The pace of change has accelerated in the past two to three years in particular, she says.

"In that time, we've seen the third-party providers we work with – such as Sustainalytics and MSCI – really focus on fixed income as a growth area.

"For example, now we see over 90% of issuers in some of the popular high-yield corporate debt indices that have ESG ratings coverage from those providers... previously, high-yield coverage was much lower, at about 30% to 40%," says Wilson.

Nuveen oversees $424 billion in fixed income assets – of which about $10 billion is currently managed according to a responsible investing mandate.

Lupin Rahman, head of emerging market sovereign credit at $1.8 trillion fixed income investment specialist Pimco, says that while "we are certainly seeing improvements... the availability, quality and coverage of ESG data for fixed income investments are still relatively weak for both sovereign and corporate issuers of bonds".

"Conventional ESG ratings look to be a bit of [trying to be] 'everything to everyone'. Often their heritage reflects an equity focus, which is visible through methodologies on governance, for example, that would have a different emphasis in fixed income."

"Conventional ESG ratings look to be a bit of [trying to be] 'everything to everyone'" Lupin Rahman, Pimco

Furthermore, ESG ratings tend not to be sufficiently integrated into fundamental analysis by rating agencies and the wider financial markets, she argues, and so lack an assessment of the financial significance of ESG risks that takes into account the specific characteristics of bond markets as well as issuer-specific factors such as credit risk.

Gaps in ESG data can be a problem for investors in sovereign bonds.

"The breadth and depth of government bond data for many countries is fairly limited and is typically only updated annually, with a time lag that can run to several quarters.

"For sovereign issuers, limitations in data availability, combined with lack of integration of that data with traditional metrics, puts constraints around achieving a robust assessment of sovereign credit worthiness."

For corporates, while data quality and coverage is improving, challenges remain, she adds.

"Data limitations mean ESG analysis still lacks sufficient detail and scale, and it is often not connected to broader credit analysis on those issuers. Often, larger conglomerates lack [ESG data] for their subsidiaries, when those subsidiaries are standalone issuers, making it more difficult to assess the entity as a whole," she says.

Nonetheless, Rahman is cautiously optimistic that the availability and quality of ESG data for fixed income is getting better.

"There is a greater focus by international financial organisations on improving data provision on government issuers, while 'big data' is being used to determine the risk of near-term events such as social protests, strikes and local environmental events," she observes.

"A key objective for the industry is to make more standardised ESG data available to fixed income investors. To this end, credit rating agencies are notably bolstering their ESG offerings.

"The introduction of green, social and sustainability bonds, and sustainable development goals (SDG) bonds, has also moved this process forward, but still more can be done to connect the data on these investments to the sustainability and business strategy of each issuer," Rahman argues.

A lack of confidence in ESG data sets leads many investors to pursue their own analysis.

Andrew Howard, head of sustainable research at $537 billion investment manager Schroders, says: "Data and corporate disclosure has improved significantly recently. However, there is still a wide gap between large and small companies, developed and emerging markets or listed and unlisted companies. This is true across both credit and equity markets.

"ESG analysis involves forming views on how companies address risks and opportunities, for which data is an important aid but thoughtful, well-informed analysts are ultimately more important," Howard argues.

Trevor Allen, a sustainability research analyst at BNP Paribas, says the French bank conducts its own assessment of how ESG issues including climate change are likely to affect bond issues with long-dated tenors.
Lupin Rahman, Pimco

"The ESG risk for long-dated bonds is definitely greater, and it's more difficult to understand how that's going to change...because there is that unknown variability that comes with [the passing of] time, but also because there is likely to be more climate-related regulation in the future.

"This is why we are putting a lot of energy into [assessing the potential impacts on] the long-dated part of the curve. It's an assessment that we are having to do in-house, rather than use ESG data ratings," Allen says, noting that this type of information is currently lacking among data providers.

"It's very difficult for anyone to stand by an assessment of 30 years, unless you have a lot of conviction. There are so many different factors that you almost have to do a bespoke analysis - and this will become more popular in future," Allen predicts.

Nuveen's Wilson agrees that, despite progress in recent years, there are still significant gaps in coverage of ESG data in fixed income – particularly for US municipal issuers, and in the structured debt market. The latter category includes asset-backed securities (ABS) and mortgage-backed securities (MBS).

"Just because the third-party data providers don't cover those portions of the asset class, doesn't mean we ignore ESG in this area – we fill those gaps with our own work. Nuveen has designed an ESG score for municipal issuers, which to date covers about 20,000 muni issuers," she says.

"For ABS and MBS, we are looking at the underlying capital that is tied to those securities. In particular, we are looking to positive impact opportunities such as solar leases that could be securitised... or avoiding risks, taking a closer look at sub-prime residential mortgages, for example."

Wilson believes there are currently many areas where ESG data providers miss nuances that are necessary to understand how ESG issues potentially affect fixed income investments.

She summarises these as the difficulty to:

  1. assess the credit materiality of ESG issues;
  2. assess ESG issues over a long time horizon;
  3. ensure wide coverage of the investable universe of debt, in comparison to equity;
  4. evaluate the direct social and environmental impact resulting from projects financed by bonds; and
  5. evaluate exposure to risks that are specific to a project's location, such as climate change or water scarcity.

"The time-horizon aspect is unique to fixed income... bonds can be very long-dated, and as a long-term investor, we're interested in ESG analysis that takes that into account," she says.

"ESG ratings providers do not typically provide a time horizon for their ratings. However, most of the information used to arrive at the rating is backward-looking, focusing on perhaps the last three to five years of corporate or government ESG performance. Meanwhile, debt can be issued for 10-, 20-, or even 100-year maturities, leading to potential mismatches depending on how long an investor actually intends to hold the bond.

"When you think about the universe of issuers that's covered, even in the corporate space, they are quite different from those in the listed equity space.

"We still see a gap between the coverage of equity issuers and debt issuers, even down to subsidiaries level; you could have a subsidiary of a listed equity company issuing debt that has very little to do with the business of the parent, and that may warrant separate ESG analysis.

Nuveen responded to a recent MSCI consultation on the municipal bond market. The data provider is considering evaluating positive impact in this area, Wilson explains.

"They are also looking at the issue of the debt-issuing subsidiary, which may be in a totally different business to its equity parent," Wilson explains.

"Where I don't think that the dedicated ESG data providers are doing much is on the credit materiality issue [and] the time horizon issue. I think their use of location-based data is still pretty nascent as well.

"On credit materiality, we really welcome the credit rating agencies entering this space, because they start to solve this issue of, how many of these ESG factors are material to credit? So far, we've been having to do that work ourselves," she says.

"On credit materiality, we really welcome the credit rating agencies entering this space, because they start to solve this issue of, how many of these ESG factors are material to credit? So far, we've been having to do that work ourselves," Sarah Wilson, Nuveen

In May, credit rating agency Moody's launched a consultation on a proposed scoring system for assessing carbon transition risk among publicly traded non-financial companies.

The rating agency said the assessments are intended to provide market participants with a greater level of visibility and transparency into how Moody's assesses carbon transition risk.

It stressed that the proposed 'carbon transition assessments' are not credit ratings and do not directly affect credit ratings. It added, however, that "carbon transition risk is one of many considerations that already inform our views of credit ratings". The consultation closed on 6 July.

This is symptomatic of a wider push by credit rating agencies (CRAs) to integrate ESG into their analysis of issuers.

In April, Moody's acquired a majority stake in ESG research and ratings provider Vigeo Eiris, while S&P launched an ESG evaluation tool – which is separate from its credit rating. Moody's has since purchased a majority stake in climate risk data firm Four Twenty Seven.

In February, S&P included a dedicated ESG section in its credit ratings reports for the first time. Moody's is understood to be considering putting a separate section on its ratings reports that is devoted to ESG considerations and how they might be reflected in its ratings.

Meanwhile, Fitch published a study in January, which explains how ESG factors impact its credit rating decisions for more than 1,500 individual corporate issuers.

Many market participants see the increasing involvement of CRAs in this space as an important catalyst for improving the ESG data available to fixed income investors, because of their specialism in analysing credit-material factors – which increasingly include ESG.

It is for this reason that "the CRAs could be really formidable competitors" with more conventional ESG data providers such as MSCI and Sustainalytics, Robert Fernandez, a vice president and director of ESG research at Breckinridge recently told Environmental Finance.

Myriam Durand, global head of assessments at Moody's Investors Service, says: "Moody's is committed to advancing global ESG standards by providing ESG data and assessments to market participants. Our recent investments in Vigeo Eiris and Four Twenty Seven will broaden our ESG capabilities, and create an opportunity to leverage new data to further enhance our credit ratings and research."

Lauren Smart, a managing director and global head of financial institutions business at data company Trucost, which was purchased by S&P in 2016 and is now part of its Market Intelligence business, says: "Fixed income investors are going to be much more focused than equity investors on issues that will affect the bottom line.

"S&P Market Intelligence provides a lot of the credit models to investors, which can say, for example, under different energy transition scenarios, what the impact would be on revenues, on costs – and we can see how those scenarios would feed through to bottom line of a company's financials, and can then input those adjusted financials into credit models to understand the likelihood of default, and the notch change [in the credit rating].

"This is pretty cutting-edge stuff, and new to the market. It helps to address the specifics of what a credit investor needs to look at," Smart says, adding that it is continuing to develop work in this area.

Nuveen's Wilson is confident that recent strides in the ESG space by CRAs, as well as improvements in the quality of ESG data for fixed income more broadly, are a sign that positive change is in process.

She believes it could soon be an asset class that investors from across the proverbial fence in equities could be keeping a keen eye on.

"Fixed income is the next frontier for innovation in the ESG data space" Sarah Wilson, Nuveen

"Fixed income is the next frontier for innovation in the ESG data space... because it expands ESG to new sectors of the economy and offers investors the ability to really focus on projects and investments that can achieve impact," Wilson explains.

This article is part of a series of features exploring ESG data.

  • To read 'The ESG data files – introduction, click here
  • To read 'The ESG data files – part one: reported data', click here
  • To read 'The ESG data files – part two: non-reported data', click here
  • To read 'The ESG data files – part three: ESG rating agencies', click here
  • To read 'The ESG data files – part four: fixed income data’, click here
  • To read 'The ESG data files – part five: the impact of the EU’s taxonomy’, please click here
  • To read 'The ESG data files – part six: TCFD and the challenge of looking forward’, click here