Investors and credit rating agencies (CRAs) are ramping up efforts to consider environmental, social and governance (ESG) factors in credit risk analysis.
In fixed income, a key application for ESG information is to inform analysis of issuer creditworthiness. ESG issues, such as corruption or climate change, are potential risks to macro factors that may affect an issuer’s ability to repay its debt.
Fixed income investors apply ESG filters or screens to their investment universe to control which issuers or securities are considered for investment. This is an effective way of ensuring their investments are aligned with their (client’s) ethical motivations and reduces reputational risks.
Debt and equity holders both stand to benefit financially from successful engagements, as ESG-related risks are mitigated and opportunities maximised.
Governance factors such as institutional strength and political risks will have an impact on a sovereign’s ability and willingness to repay its debt on time. A country’s exposure and resilience to systemic environmental risks such as water scarcity will affect economic outputs, borrowing and its ability to attract foreign investment ...
Analyses of governance factors such as remuneration and financial auditing are common among bond investors, but few systematically integrate a wide range of ESG factors into credit analysis.
Case study by Itaú Asset Management
In recent years, investors have become increasingly sensitive to the potential financial impacts of risk management failures, malpractice fines and banks’ ability to meet new regulatory standards.
The PRI, Hermes Investment Management and M&G discuss ESG engagement among fixed income investors.