By Carmen Nuzzo, Head of Fixed Income, PRI and Jonathan Jones, Analyst, Investment Practices, Fixed Income, PRI

The incorporation of environmental, social and governance (ESG) factors in securitised products is still in its infancy – largely due to the complex nature of the market. However, investor interest is growing.

The discussion is quickly evolving from why to how: investors are now looking for more information to perform robust due diligence on securitised products. Recognising that this effort cannot be one-sided, the PRI is taking steps to connect investors with various stakeholders, starting with banks and credit rating agencies (CRAs), to address the challenges surrounding ESG incorporation in this asset class.

Reaching out to banks

On 8 September, we will host a webinar with the United Nations Environment Programme Finance Initiative – Accelerating ESG Incorporation by Banks and Investors. It will mark the beginning of a joint effort to ensure that ESG information is consistent and useful throughout the financing chain.

As highlighted in our seminal report, ESG incorporation in securitised products: The challenges ahead, a lack of adequate data is a major barrier preventing systematic ESG incorporation in securitised products.

Engaging with financial institutions such as banks is crucial to addressing this barrier, as they issue the loans and mortgages that typically make up the underlying assets of securitised products.[1] Doing so can help investors to better understand the extent to which these banks collect and consider ESG data in their credit risk assessments.

It can also form part of a holistic approach to ESG incorporation that enhances traditional fundamental analysis and reflects the complexity of the asset class. Such an approach would include weighing the underlying assets against environmental and social impacts, and considering an issuer’s governance practices alongside the securitisation documents.

The time for upping the game is ripe 

Several factors are driving increased investor interest in developing a systematic approach to ESG incorporation in securitised products:

  • A sharper focus on environmental and societal issues: the higher frequency of extreme weather conditions, the need to transition to low-carbon economies, and the exposure of systemic inequalities, including racial injustice and gender disparities, have propelled environmental and social factors to the forefront of investors’ minds.
  • The post-COVID recovery needs funding: securitised products can facilitate the funding of small- and medium-sized enterprises as well as lending to consumers along the credit spectrum.[2]
  • Nascent ESG securitisation market: the number of ESG-labelled securitised products is increasing. Many deals refer to the International Capital Market Association’s green, social and sustainable principles, respectively, or the United Nations Sustainable Development Goals but there are no generally accepted standards yet to ensure their veracity.
  • The regulatory landscape continues to evolve: various efforts by lawmakers are under way to improve sustainability-related disclosure by financial institutions, investors and borrowers and these could have implications for securitised products.[3]

The next steps

Later in the year, we will address the progress that CRAs have made to clarify how ESG factors feature in their securitised product rating methodologies, extending the work of the ESG in credit risk and ratings initiative. CRAs hold an important role, as their rating opinions shape the payment structure that determines the order of creditor payments in the event of default.

Furthermore, we intend to foster collaboration with other stakeholders to strengthen the ESG information used in deal documentation, marketing materials and underlying portfolio disclosures.

We will also publish a series of case studies to illustrate how investment managers are addressing client requests and extracting relevant information from issuers, driving progress and developing leading practices.

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