Global sustainable investments now exceed USD 30 trillion. Usually sustainable investment involves screening investments to avoid certain activities, such as tobacco, but increasingly environmental, social and governance factors are being integrated into investment analysis itself.
ESG integration involves a systematic analysis of all the material environmental, social and governance risks that companies face over the medium to long term. Much ESG research focuses on equity investors rather than bond investors, but we think fixed-income analysts should approach ESG differently to equity analysts, in several ways.
First, credit analysts mostly focus on avoiding losses whereas equity researchers look for potential gains. Second, while credit analysts look for specific issues such as legal or regulatory action, or consumer boycotts that might lead to a concrete credit event, equity analysts consider a wider range of ESG issues that could influence share prices.
Third, a company’s response to an ESG risk could favour or disadvantage bond investors over shareholders: credit analysts must thus discern not only the ESG risks but also evaluate how the firm might respond.
Good ESG analysis can identify emerging risks that threaten credit quality, as well as company-level preparedness to modify and deal with these challenges.
A two-year study of 9,000 corporate research updates found that nearly 8 per cent of credit downgrades involved environmental and climate factors such as the global warming-related issues that have affected European utility companies. The mining sector has also seen a substantial number of critical ESG-related events.
ESG investing is different from the longer-established socially-responsible investing, or SRI, which involves investing from an ethical viewpoint, avoiding sectors such as alcohol or gambling. By contrast, ESG analysis can improve returns by taking into account factors often left out of traditional investment analysis.
Green-bond investing has grown very rapidly in recent years but hitherto investors focus has been on how the bond’s proceeds are spent on environmentally-friendly projects whereas an ESG approach focuses on the entity issuing the bond. Firms do not need to be green to issue green bonds.
We use ESG analysis to uncover, sector-by-sector, risks or disruptions that could negatively impact yield spreads. However, good ESG analysis goes beyond attempting to discern emerging ESG risks. It requires identifying a transmission mechanism – typically a regulation or law – that might translate the risks into a meaningful credit impact.
Companies with strong corporate governance may be able to identify these emerging risks early. They may have procedures in place to ameliorate these unfolding dangers before they start impacting the firm’s credit fundamentals.
But ESG analysis involves more than just looking to future risks. Some risks are already working their way through different sectors, appearing as operational risk rather than event risk. How these factors will continue to impact firms must also be considered.
We think this analysis will become increasingly important as governments use regulation or permit regimes to make firms ‘internalise’ external factors like pollution.
We regard ESG analysis as an integral part of the investment process because of the insights it brings and the ESG-related credit-ratings applied to bonds. Increasingly, governments, central banks and regulators are urging asset managers, insurers and bankers to focus on climate change and consider ESG risks in their investment procedures.
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Disclosure and disclaimerMore, collapsed
The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Michael Ridley
Fixed income: Basis for financial analysis
This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other considerations.
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has three principal aims in its fixed income research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies in corporate credit and based on country-specific ideas or themes that may affect the performance of these bonds in the case of covered bonds, in both cases on a six-month time horizon; 2) to identify trade ideas on a time horizon of up to three months, relating to specific instruments and segments of the yield curve, which are predominantly derived from relative value considerations or driven by events and which may differ from our long-term credit opinion on an issuer. Buy or Sell refer to a trade call to buy or sell that given instrument; 3) to express views on the likely future performance of sectors, benchmark indices or markets in our fixed income strategy products.
HSBC has assigned a fundamental recommendation structure, as described below, only for its long-term investment opportunities.
HSBC believes an investor's decision to buy or sell a bond should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of terms as well as different systems to describe their recommendations. Investors should carefully read the definitions of the recommendations used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the recommendation. In any case, recommendations should not be used or relied on in isolation as investment advice.
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Definitions for fundamental credit and covered bond recommendations from 22 April 2016
Overweight: For corporate credit, the issuer’s fundamental credit profile is expected to improve over the next six months. For covered bonds, the bonds issued in this country are expected to outperform those of the other countries in our coverage over the next six months.
Neutral: For corporate credit, the issuer’s fundamental credit profile is expected to remain stable over the next six months. For covered bonds, the bonds issued in this country are expected to perform in line with those of the other countries in our coverage over the next six months.
Underweight: For corporate credit, the issuer’s fundamental credit profile is expected to deteriorate over the next six months.
For covered bonds, the bonds issued in this country are expected to underperform those of other countries in our coverage over the next six months.
Prior to this date, fundamental recommendations for corporate credit were applied on the following basis:
Overweight: The credits of the issuer were expected to outperform those of other issuers in the sector over the next six months.
Neutral: The credits of the issuer were expected to perform in line with those of other issuers in the sector over the next six months.
Underweight: The credits of the issuer were expected to underperform those of other issuers in the sector over the next six months.
Distribution of fundamental credit and covered bond recommendations
As of 19 August 2019, the distribution of all independent fundamental credit recommendations published by HSBC is as follows:
All Covered issuers Issuers to whom HSBC has provided Investment Banking in the past 12 months
Count Percentage Count Percentage
Overweight 128 24 79 62
Neutral 271 50 133 49
Underweight 138 26 57 41
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