ESG (environment, social, governance) investing has been expanding for several years now, but it has undergone exponential growth since the pandemic. According to Moody’s, issuances of labelled GSS bonds (comprising of green, social and sustainability bonds] reached a record USD491 billion in 2020.1 That, however, looks set to be eclipsed this year with data from Refinitiv showing that USD264 billion of labelled GSS bonds had already been issued by the end of Q1 alone.2 Of that total, issuances of green bonds accounted for USD130 billion, followed by social bonds (USD91.3 billion) and sustainability bonds (USD43 billion).3 Experts at HSBC’s Markets and Securities Services Forum – Opportunities in 2021 and Beyond – shared their insights looking at the drivers fuelling the tectonic growth in ESG investing.
ESG momentum barges on
“In order to push global emissions down to net zero, there needs to be greater financial innovation,” said Dr Michael Ridley, director and senior responsible investment specialist at HSBC Global Asset Management. This is now happening. Accelerating the rising investor appetite for sustainable bonds is the growing diversity of ESG investment products now available to them, said Patrick Kondarjian, managing director, head of EMEA Wealth Sales and Global ESG Product at HSBC. Similarly, a wider range of issuers – such as technology companies - are now launching sustainable bonds in what is helping to deepen the market further. All of this is leading to growing investor participation in the ESG market. Kondarjian said that while the ESG investor base had historically been very euro-centric, there is now increasing interest from Asia-Pacific together with the US, especially since the new administration took office. In addition, changing investor demographics are driving inflows into ESG assets too. “Younger investors are more focused on ESG. ESG is an area where asset managers have an excellent opportunity to distinguish themselves,” continued Shay Lydon, partner at the asset management group at Matheson.
Regulation is also playing a material role in facilitating the rise of ESG. EU regulators – for example – introduced the SFDR (Sustainable Finance Disclosure Regulation), which forces institutions such as asset managers to report on how they apply sustainability metrics into their investment activities. Farnam Bidgoli, Managing Director, Head of ESG Solutions, EMEA, at HSBC, welcomed the mandatory ESG disclosure requirements, adding that it was forcing the industry to move in the right direction. Meanwhile, the EU’s Taxonomy Regulation is expected to provide clarity on what economic activities should be deemed sustainable – a policy which could lead to greater flows into ESG assets.
Other markets are also taking an equally progressive stance on ESG regulation. Henry Raschen, Regulatory Outlook, Markets and Securities Services at HSBC, said domestic policymakers in the UK were initially focused on introducing TCFD (Task Force on Climate-related Financial Disclosures) aligned disclosure rules for large listed companies although they are now developing proposals to extend this to a wider range of issuers. Raschen continued that UK regulators plan to consult on whether to apply these disclosure requirements to asset managers, life insurers and FCA (Financial Conduct Authority)-regulated pension schemes.4 Elsewhere, Raschen said that the People’s Bank of China was collaborating with the EU to establish some common ground on the green taxonomy5, adding that the US is also stepping up its focus on ESG6.
Challenges still need to be navigated
Although ESG’s popularity is not in doubt, there are some challenges which need to be overcome. For instance, some corners of the ESG market – such as impact investing or blue bonds – simply do not have the scale or capacity to handle actual demand. Kondarjian warned there was a growing disconnect now emerging between the availability of projects and investment size; risk profile and liquidity. As investor demand for assets, such as green bonds, rises, yields are starting to fall with research by Mirova, an asset manager, showing investors could lose up to 2 basis points of yield when buying green bonds over non green bonds.7 Bidgoli said this green premium – otherwise known as the ‘Greenium’ - was a direct consequence of demand simply outstripping supply.
Lydon commented that ESG investing is also constrained by the inconsistent approaches being taken towards it by market participants including investors, global regulators and ratings agencies. In the case of regulators, different markets are adopting their own rules, leading to potential divergences. Meanwhile, ratings agencies each use their own specific methodologies and weightings to score companies on ESG. However, this can often result in identical companies receiving different or even conflicting ESG scores from the various ratings agencies. All of this creates confusion for end investors. However, leading providers – including HSBC Securities Services – are developing ESG portfolio reporting tools to help clients avoid some of the pitfalls associated with ESG investing. “HSBC’s view is that ESG scores represent research information, and that the resulting variability can be embraced by taking comparative ESG views from different leading providers. This capability can be made available to clients of Securities Services who use the ESG portfolio reporting product,” said Chris Johnson, senior product manager, market data, Markets and Securities Services at HSBC.
An ESG balancing act
A combination of product innovation – which has increased the range of ESG investment options - along with regulatory intervention to strengthen client confidence - is sparking widespread investor interest in ESG. However, the Greenium, a lack of liquidity in certain parts of the market, and variations in regional and national regulations all need to be overcome if investor appetite for ESG is to reach the levels necessary to help facilitate net zero.
1Environmental Finance (February 22, 2021) Trends in sustainable bonds issuance and a look ahead to 2021
2Reuters (April 15, 2021) Sustainable bond issuance reaches record high in first quarter
3Reuters (April 15, 2021) Sustainable bond issuance reaches record high in first quarter
7Institutional Asset Manager (April 7, 2021) Evidence of greenium grows as demand for green bonds outstrips supply