Responsible investment in fixed income quarterly update

20 October 2020

The divergence between US and European attitudes to environmental, social and governance (ESG) factors continued in the third quarter, as the US Department of Labor proposed further rules preventing some fiduciaries from voting on issues with a non-financial impact, while sovereigns in Europe issued new impact bonds and the European Central Bank signalled it would allow sustainability-linked bonds in its asset purchase programme. Growth in impact bonds continued, with year-to-date 2020 issuance now ahead of issuance throughout 2019. Insight continued to engage with issuers over ESG matters, and to analyse impact bonds.

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Index


Highlights

  • Sovereigns step up to the impact bond market, as Germany and Sweden issue their first green bonds and Luxembourg becomes the first European country to launch a sustainability bond framework

  • In the US, the Department of Labor proposed further restrictions on some pension plan fiduciaries that could limit the consideration of environmental, social and governance (ESG) issues in voting and engagement decisions

  • The European Central Bank (ECB) signalled its support for innovation in sustainable finance, extending eligibility for its asset purchase programme to include sustainability-linked bonds

Regulatory and industry news

  • Sovereigns starting to play a bigger role in impact bond issuance: Germany and Sweden became the latest sovereigns to come to market with green bond issuances of €6.5bn and kr20bn, respectively. Germany’s inaugural issuance was over five times oversubscribed. The next day, German carmaker giant Daimler also announced the issuance of its first green bond. Separately, Luxembourg raised €1.77bn with Europe’s first ever sovereign sustainability bond, dividing the proceeds between green and social projects.

  • US Department of Labor proposes yet more restrictions on ESG investments: Following the Department’s action to restrict some fiduciaries’ considerations of ESG factors in their investment decisions earlier in the year, it proposed an additional set of rules that could further limit the engagement of fiduciaries on ESG matters. The proposal states that Employee Retirement Income Security Act (ERISA) plan fiduciaries should either abstain from voting in shareholder matters related to non-financial factors altogether, or policies should be put in place that require fiduciary votes to default to the management recommendation – therefore ensuring that ERISA plan fiduciaries are driven only by financial considerations.1

  • ECB plans on buying back sustainability-linked bonds (SLBs) with coupon step-up from 1 January 2021: The ECB announced it would accept SLBs as collateral and as eligible for its asset purchase programme, provided that the SLBs comply with specific criteria. The programme-specific criteria, which previously excluded SLBs due to their linking of coupons to an issuer’s sustainability profile and thus rendering the coupon structure “a priori uncertain”, will now be extended to incorporate sustainability performance targets. 2

  • A series of ‘firsts’ for SLB issuance, with the first-ever SLB issuance from emerging market, the luxury goods sector and the healthcare industry: Suzano, the Brazilian pulp and paper producer, issued US$750m of SLBs in September, with coupons linked to meeting greenhouse gas emission targets. This is the first SLB the market has seen from an emerging market issuer. Other firsts included Chanel marking the luxury goods sector’s debut SLB issuance of €600m, and Novartis issuing the first SLB issuance in healthcare, totalling €1.85bn linked to patient access targets. The issuances came after the International Capital Market Association set out its best-practice principles for SLB issuance earlier in the year.

  • Launch of Task Force on Nature-related Financial Disclosures (TNFD): A broad range of financial institutions, governments, regulators and UN-affiliated agencies launched the TNFD, which aims to coordinate a unified global response to nature-related financial risks. The framework aims to develop broader disclosures than the Task Force on Climate-related Financial Disclosures (TCFD). Through the development of an international reporting standard, the TNFD aims to cater to the nature-related reporting, metrics and data needs of financial institutions.3

Insight Investment decisions reflecting ESG factors in Q3 2020

Sector Asset class ESG risk factor Comments Investment decision Insight ESG rating
Real estate Active Governance Key-man risk materialised as an individual responsible for improvements in governance and transparency was leaving the firm. This, coupled with a complex governance structure, led us to view the investment opportunity negatively and we sold our remaining holdings. SELL
Apparel Active All A new issuer to the market, this was identified as best-in-class under our ESG ratings with a robust sustainability framework. We decided to buy its new sustainability issuance. BUY
Insurance Buy & maintain All Having been identified as worst-in-class under our ESG ratings, we moved to a ‘hold’ position for this company while our analyst engaged with management on material ESG concerns including responsible investment and carbon financing. HOLD 5
Retail Buy & maintain All The company was downgraded to a 5 under our ESG ratings. We moved to a ‘hold’ position while our analyst engages with the company on material ESG concerns including labour management and anti-competitive practices. HOLD 5


This is an illustrative list of investment decisions affected primarily by ESG factors, selected to demonstrate the role of ESG analysis in our research and decision-making. 1= high ESG rating; 5 = low ESG rating.

Impact Bond issuance in Q3 2020

A note on responsible investment and impact bonds: Investing responsibly means taking ESG risks into account across all portfolios. Impact bonds may bear similar ESG risks to traditional bonds. Investing in them does not mean you are necessarily taking a more responsible approach, but they can be an effective way to have a positive environmental or social impact with your investments.


Total issuance (USD) by sector and by year4 

Impact bond issuance by sector and by year

Impact bond issuance by sector and by year - chart 2

Largest impact bond issues in Q3 20205

Issuer Issue type Size of issue Bond type
Bundesrepublik Deutschland Bundesanleihe Government €7.67bn Green
Sweden Government International Bond Government kr2.28bn Green
NRW bank Financial or Banks €1.13bn Social
Council of Europe Development Bank Supranational Bank €1.09bn Social
Caisse Francaise de Financement Local Government €1.08bn Social


Insight impact bonds ratings in Q3 2020

Our analysis of 32 impact bonds issued in Q3 2020 resulted in the following ratings:

bonds were rated green, indicating the bond meets Insight’s minimum sustainability requirements
bonds were rated amber, indicating there are weaknesses in the bond with regard to sustainability
bonds were rated red, indicating the bond does not meet Insight’s minimum sustainability requirements


Sample of Insight Investment's impact bond analysis in Q3 2020

Name Bond type ESG performance met? Bond framework criteria met? Impact criteria met? Traffic light score
Icade Sante (real estate) Social Yes Yes Yes
Analyst assessment: The bond’s proceeds may be used for accessing essential services through investment in hospital and elderly care real estate in France. We rated this bond amber. This could have been a green rating as it ticks the boxes in terms of the key pillars of a framework and the company has an opportunity to create clear social impact. However, it appears to be refinancing a larger proportion of the proceeds, which in our view is less impactful.

 

Name Bond type ESG performance met? Bond framework criteria met? Impact criteria met? Traffic light score
German government (sovereign) Green Yes Yes Yes
Analyst assessment: The bond’s proceeds may be used for: international co-operation (assisting developing countries with the transition to low carbon economy); energy and industry (applied research on renewables and measures to increase sustainable heating/cooling); agriculture, forestry, natural landscapes and biodiversity (forest protection, extreme weather management, organic farming); research, innovation and awareness raising (support/facilitate knowledge and innovation on the climate/environment such as biodiversity and nature protection). We rated this bond green. The framework is very clear and detailed, providing sufficient transparency on how the proceeds would be split across each category with clear impact.

 

Name Bond type ESG performance met? Bond framework criteria met? Impact criteria met? Traffic light score
Volkswagen (automotive) Green No Yes Yes
Analyst assessment: The bond’s proceeds may be used for clean transportation (primarily funding electric vehicles and related charging infrastructure). We rated this bond amber. The issuer remains to be a UN Global Compact violator and has a worst-in-class ESG rating, and therefore does not meet the criteria to be rated green. However, the framework is clear and in line with the market standard.

 


1https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/fact-sheets/fiduciary-duties-regarding-proxy-voting-and-shareholder-rights

2https://www.ecb.europa.eu/pub/pdf/other/EN_ECB_2020_45_f_sign~6a8d473bbe..pdf?627f0f21a7d1e0cda138204feb43c2e5

3https://www.responsible-investor.com/articles/what-a-task-force-on-nature-related-financial-disclosures-will-achieve

4Source: Insight Investment. Bloomberg data as at 30 September 2020.

5Source: Bloomberg. Selected by Insight according to absolute value of local currency.

Important Information

Past performance is not indicative of future results. Investment in any strategy involves a risk of loss which may partly be due to exchange rate fluctuations.

Associated investment risks

Fixed income

Where the portfolio holds over 35% of its net asset value in securities of one governmental issuer, the value of the portfolio may be profoundly affected if one or more of these issuers fails to meet its obligations or suffers a ratings downgrade.

A credit default swap (CDS) provides a measure of protection against defaults of debt issuers but there is no assurance their use will be effective or will have the desired result.

The issuer of a debt security may not pay income or repay capital to the bondholder when due.

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Investments in emerging markets can be less liquid and riskier than more developed markets and difficulties in accounting, dealing, settlement and custody may arise.

Investments in bonds are affected by interest rates and inflation trends which may affect the value of the portfolio.

Where high yield instruments are held, their low credit rating indicates a greater risk of default, which would affect the value of the portfolio.

The investment manager may invest in instruments which can be difficult to sell when markets are stressed.

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