Forgive my desecration of Einstein’s equation for relativity but it makes my point. Investors seem to increasingly value the ‘E’ of ESG more than the other parts.
It’s a work in progress for analysts and investors getting to grips with Socially Responsible Investing, underpinned by ESG reporting and a range of “ESG Frameworks” offered by consultants in the growing market for ESG labelled securitization.
Regulators are moving as to what the FCA called, in its November 2021 ESG Governance Strategy paper, “Trust and transparency” and the development of tools to deliver “internationally consistent outcomes in ESG”.
But in recent ESG bond issues more focus is being placed on the environmental factors rather than the social or governance outcomes being delivered.
The evolution from traditional financial analysis of a company to one that includes an assessment of ESG factors is bound to take some time.
Reporting needs to develop and standardise. And the easiest place to start is with facts – things that can be measured and compared, exactly where the “E” factor wins out at present. “S” and “G” factors are still more matters of judgement.
A company can report decarbonisation results and an analyst can draw a graph. Graphs tell stories – everyone loves a story.
Investors want to be able to compare A to B. After all, it is not till you see a person standing next to others that you realise how tall or short he or she is.
Much easier to report emissions targets than it is for inconsistent measurements of “customer empathy”, “staff engagement” or “respect for shareholders”.
Last year, L&Q, a large social housing provider issued its first “Sustainability Linked Bond” for £300m, and set out KPI targets, which could, if missed, trigger penalty interest premiums.
These relate to emission reductions, energy efficiency of homes and a new homes building target. L&Q, being the sort of organisation they are, underpin this environmental focus of their bond with the assurance of their published “Sustainability Finance Framework” stating their commitment to social and governance measures such as reliable customer services and representative governance.
In the mortgage market, Kensington’s £750m Green Bond, also issued last year, combines several issues, but again with a focus on clearly measurable environmental results.
Does it matter if all the focus is on environment concerns? Yes, since the whole framework for “ESG” is based on ethical conduct in the round – leading to long term risk minimisation and improving financial performance.
Good performance in one leg of ESG could be used to mask shortfalls in another. Great “green credentials” by a mortgage lender could take attention away from poor staff retention, broker satisfaction, predatory treatment of customers in arrears or the abuse of mortgage prisoners. ESG is a three-legged stool – and it won’t work on one leg alone.
The emerging lesson is that using one simple off the shelf framework will prove inadequate. Investors need to develop their own analysis of matters important to their sector – and to look through the veneer of environmental factors to consider the full ESG risks.
Lenders need to develop consistent measures and reporting of customer, staff, shareholder and other stakeholder concerns and proffer these to the market. It really is work in progress…….
Mark Davies is managing director of BCMGlobal
