Every investor wants environmental, social and governance (ESG) exposure, but only the largest have the resources to comprehensively assess this for themselves.
As the demand for standardized measurement grows, fixed income in particular has a lot of work to do to catch up.
In January, index provider MSCI launched a series of new fixed income ESG and factor indexes, a recognition that investor demand for ESG integration in fixed income is rapidly outpacing current offerings.
“The indices were launched to meet client demand,” explains Hitendra Varsani, factor strategist at MSCI. “Clients want to target fixed income exposures that align with their own objectives and many global asset owners are demanding ESG integration.
“There has been strong growth in equities, but the choice in fixed income is relatively more limited.”
MSCI has operated an ESG Leaders Index in the equity markets for several years and is now applying it to fixed income. It is also launching an ESG Universal Index for fixed income. These products apply ESG ratings from triple-A to triple-C; they incorporate ESG controversies consistent with international norms and screen businesses for involvement in certain activities.
Fitch recently published a ranking of the top 11 corporate sectors by negative screening, which put metals and mining at number one and technology and media at number 11. The higher ranked corporates, with the exception of gaming, lodging and leisure, tended to be screened out on environmental issues while the lower ranked on governance issues.
“So far, only Standard and Poor’s and Fitch have disclosed statistics on the actual number of financial and non-financial issuers which had their credit rating impacted by ESG considerations, and these remain limited [28 for S&P and 345 for Fitch],” says Ines de Tremiolles, global head of Credit 360 at BNP Paribas, recently.
“The main obstacles declared by the credit rating agencies have been the lack of visibility on ESG factors and the materiality of ESG risks within the rating horizon.”
Materiality has become a key concept in the drive to embed ESG into the investment process.
“We are looking at the financial materiality of ESG factors in fixed income,” Varsani confirms when asked about the construction of the new indices. But how should materiality be measured?
The financial materiality of ESG factors involves establishing what sustainability issues are material to different companies and industries.
“It is generally acknowledged that material ESG issues by industry can change over time for a variety of reasons,” says Robert Eccles of Saïd Business School, Oxford University, and the founding chairman of the Sustainability Accounting Standards Board (SASB).
Given how central materiality is to ESG investing and fiduciary duty, it is critical to understand the mechanisms by which ESG factors impact the operational and financial performance of companies
– Andre Shepley, Truvalue Labs
He adds that there are three core materiality issues – greenhouse gas emissions, labour practices and business ethics – that have been especially important for the past 10 years because of their system-level effects.
It is, therefore, crucial that an agreed measure of materiality can be determined.
At the end of January, San Francisco-based Truvalue Labs published a paper introducing the concept of dynamic materiality: that every company, industry and sector has a unique materiality signature that evolves over time based on factors such as emerging technologies and new regulations.
The firm, which specializes in artificial intelligence-driven ESG data, says that this indicates that ESG materiality is driven by stakeholders’ perspectives regarding individual companies, in addition to factors related to the industry and sector as a whole.
“Given how central materiality is to ESG investing and fiduciary duty, it is critical to understand the mechanisms by which ESG factors impact the operational and financial performance of companies,” says Andre Shepley, head of fundamen