Regulation remains among the main drivers of this ESG acceleration, it triggers significant challenges at industry and sector levels while contributing to raising awareness on thematic issues such as biodiversity and environmental protection, decarbonisation pathways and GHG emissions, water management, human rights, supply chain management, and corporate governance. The universal commitment to transition to a Net Zero economy by midcentury is also forcing issuers active in carbon-intensive sectors to further increase their investments into green technology and disruptive solutions (i.e. Carbon Capture and Storage projects, electrification, biofuels, Renewable Energy…) to remain within the Paris Agreement’s objective to limit the increase in global average temperature to well below 2° C above pre-industrial levels and pursue efforts to limit the temperature increase to 1.5 °C above pre-industrial levels. Limiting global warming to 1.5 °C by the end of the century has been a priority for world leaders hence the rapidly growing focus on ESG innovation that we are witnessing today.
Furthermore, the increase in the frequency and the severity of extreme weather events worldwide also heightens the importance of proper physical climate risk management from a credit perspective. As acute and chronic physical climate risks are prone to causing severe financial and economic losses for businesses and governments, these negative events have the potential to trigger knock-on effects on insurance premiums, affect cash flow generation, and consequently impact issuers’ ability to repay debt. Thus, the need to properly mitigate the imminent negative effects of climate change and adapt to a changing environment remain key factors to achieve long-term success.
Limiting global warming to 1.5 °C by the end of the century has been a priority for world leaders hence the rapidly growing focus on ESG innovation that we are witnessing today.
Over the past year, we have witnessed a significant increase in the complexity of today’s ESG landscape including regulatory requirements (at European and international levels), reporting standards and frameworks, ESG rating methodologies, and the increasing presence of sustainability data solution providers on the market.
In order to thrive in this evolving context, it is crucial to fully embed a company’s ESG strategy into the fundamental credit analysis when looking at corporate bond issuers. Ongoing collaboration between the credit and ESG analysts is therefore key.
A complete fundamental credit analysis should be based on several pillars, namely the assessment of a company’s business risk profile, its financial risk profile, and its ESG risk profile. In addition to the analysis performed at company level, it is also important to consider data at security/bond level (assessing structural risks, the aggressiveness of documentation, relative value of a bond, but also the quality of green bond frameworks). Through this process, we can obtain a comprehensive, substantiated opinion on a company and are then able to formulate a clear-cut conclusion on the attractiveness of its bonds.
In our view, a comprehensive ESG integration framework should be based on the 3 dimensions of the acronym, be subject to sector-specific materiality mapping, and systematically incorporate additional non-sector-specific indicators as listed below:
Environmental issues
- Environmental performance trend,
- Climate objectives, certifications, and good practices,
- Physical risk management biodiversity.
Societal impact
- Internal policy alignment with the Universal Declaration of Human Rights, International Labor Standards (ILO), and/or OECD guidelines,
- Human capital and labour relations with employees, suppliers, and other stakeholders.
Governance
- Board structure and responsibilities,
- Ownership and shareholder rights,
- Ethical and compliance measures.
Looking beyond companies’ past performance and taking into consideration the underlying aspirations shown in their ESG strategies is key.
When assessing the quality of issuers’ ESG profiles, one should approach this exercise with a critical mindset using the information published or provided directly by companies, as well as the research, data or scoring/rating issued by external providers (e.g. Sustainalytics, MSCI, Glass Lewis, CDP, TruCost, Bloomberg, etc.). More importantly, to maintain a pragmatic perspective, looking beyond companies’ past performance and taking into consideration the underlying aspirations shown in their ESG strategies is key (i.e. efforts put in place towards achieving their targets and KPIs, innovations, adaptability, etc.). This assessment allows us to forge an objective opinion on the issuers’ ESG risk profile, with potential impacts on the other pillars of our analysis, such as business and financial risks.
In conclusion, we believe that careful consideration of ESG factors in the credit analysis and credit worthiness evaluation of borrowers is essential since these factors have the potential to affect the cash flow generation capacity, the access to capital markets, the cost of debt financing and therefore the issuer’s credit quality and likelihood of default on its debt obligations.
Degroof Petercam Asset Management SA/NV (DPAM) l rue Guimard 18, 1040 Brussels, Belgium l RPM/RPR Brussels l TVA BE 0886 223 276 l
All rights remain with DPAM, who is the author of the present document. Unauthorized storage, use or distribution is prohibited. Although this document and its content were prepared with due care and are based on sources and/or third party data providers which DPAM deems reliable, they are provided without any warranty of any kind and without guarantee of correctness, completeness, reliability, timeliness, availability, merchantability, or fitness for a particular purpose. All opinions and estimates are a reflection of the situation at issuance and may change without notice. Changed market circumstance may invalidate statements in this document.
The provided information herein must be considered as having a general nature and does not, under any circumstances, intend to be tailored to your personal situation. Its content does not represent investment advice, nor does it constitute an offer, solicitation, recommendation or invitation to buy, sell, subscribe to or execute any other transaction with financial instruments. This document is not aimed to investors from a jurisdiction where such an offer, solicitation, recommendation or invitation would be illegal. Neither does this document constitute independent or objective investment research or financial analysis or other form of general recommendation on transaction in financial instruments as referred to under Article 2, 2°, 5 of the law of 25 October 2016 relating to the access to the provision of investment services and the status and supervision of portfolio management companies and investment advisors.