Climate change poses a very real threat to future of the human race. There is also a growing realisation that every part of society needs to work towards the transition to a low-carbon economy – from governments to businesses, as well as individual citizens. The financial industry also has a significant role to play.
The imminent dangers associated with rising greenhouse gasses, along with the ways that environmentally conscious investing can mitigate the risks, was the subject of a session at HSBC’s Asia Day.
“The message of consensus science, though I don’t think many people are realistically interpreting it, is that we are very close to a point where we simply lose control of the ecosystem that we depend on for life,” said Jonathan Drew, Managing Director, Infrastructure and Real Estate, HSBC.
The average global temperature has already risen by approximately 1C versus pre industrialised time1, and Mr. Drew said that per the IPCC we are approaching a number of irreversible tipping points. As temperatures pass 1.5°C the likelihood of the complete melting of the Greenland Ice Sheet increases significantly, which would eventually cause sea levels to rise by an estimated 5-7 meters. There is also heightened risk that methane trapped underneath the Antarctic ice could be released into the atmosphere, which as a highly potent greenhouse gas, would accelerate global warming even more.
There are two broad ways that sustainability can alter an investor’s view towards a company. They can look for businesses that are actively addressing climate change risks, with a view that this kind of company will outperform its peers in the future. Or they can actively avoid investing companies that will be negatively impacted by a changing environment. Ratings agencies deal primarily with the latter option, and they are actively developing frameworks to incorporate sustainability into their assessments.
“At Moody’s we have always considered ESG in our ratings and ratings methodologies however we are now working on articulating in a far greater level of detail, how such risks are built into our ratings. At the same time we are developing assessment tools to measure a company’s relative exposure to each of E and S and G,” said Ian Lewis, Associate Managing Director, Moody’s Investor Services.
More transparent integration of ESG measures into credit ratings is an inevitable step, he said, though it is a reasonably complex process that will involve several stages. Developing a global taxonomy for example, is an important part of the early process, as it creates a standardised terminology for all parties to use.The agency is also planning to develop powerful assessment tools which can assist market participants in understanding and dimensioning relative ESG risks across sectors, peer groups and for individual issuers.
Sectors are then ranked according to their exposure to transition risks. The companies facing the most immediate risks are coal miners and power utilities, while the shipping and the automotive industry is like to face pressure over the medium term. Each issuer is then given a carbon transition score that is relative to its peers in the sector that it operates in. The result is data that an investor can use to make a more informed investment decision.
The role of banks
There is clearly interest among the investment community to allocate capital towards sustainable projects. There are over 2,000 signatories for the Principles of Responsible Investing, with combined assets under management worth approximately USD80 trillion.
“The capital is there, and the pressure is on the financial industry to connect that money to the right projects,” said HSBC’s Mr. Drew.
To do that, the banking industry is developing an expanding suite of sustainable financial products. Green, social and sustainability bonds have quickly become a mainstream part of the fixed income market, with issuance rising sharply each year. In first five months of 2019, USD124 billion worth these bonds were issued, a 48 per cent increase on the same period in 2018.
“Green bonds are very relevant for real estate companies for example,” said Mr. Drew. “And companies in Singapore have raised responsible capital to support the financing and refinancing of green buildings.”
Green loans are a newer product, which has taken off since the Loan Market Associations globally launched the Green Loan Principles in March 2018, with more USD70 billion in credit already distributed via this channel according to Dealogic. Other products include Sustainability Linked Loans, where the margin or spread of the debt is linked to the borrower achieving improved ESG or sustainability criteria.
For the recipients of green capital, perhaps the biggest benefit is favourable pricing. “The bond market continues to show evidence that the demand for green bonds is enabling issuers to get better pricing when they take their bonds to market under green frameworks than if they did with a traditional bond,” said Mr. Drew. “There is also growing evidence of green bonds achieving higher prices in secondary trading.”
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