Defining the ‘green bond’

Asset Class in Focus

Any definition should be principles-based, permitting the investor flexibility to decide if the green bond is actually green, according to Mitch Reznick, Hermes IM.

The European Union is working on a formal definition of a green bond, which is expected this year.

Reznick, head of credit research and sustainable fixed income at Hermes Investment Management, said he hopes the EU will not put forth a regulatory definition “that would have the rigour of law” because it would likely limit green bond issuance.

“It would be so restrictive that it runs the risk of undermining the benefits of green bonds in some areas,” he told FSA. Regulatory product definitions can be so narrow that the cost of issuing a green bond would increase, in which case “nobody would bother”, he added.

Instead, he argues for “a principles-based definition” that allows the investor to do the work and determine whether the principles are adhered to.

“There is no regulation that specifically defines what is required to assign a high yield or investment grade credit rating. Credibility rests with investors and credit rating agencies.

“The same should be true for a green bond. You must read the documentation, understand the uses, and determine if reporting is sufficient to meet the expectations of underlying investors.”

Data challenges

Reznick said issues surrounding data represent the biggest ESG challenge. Specifically, measuring the effectiveness of an ESG investment and company reporting of ESG data.

In Asia, ESG data is often difficult to get because the company simply does not have the data, according to Adrie Heinsbroek, NNIP’s head of responsible investment. “Companies or issuers may also have difficulty understanding what investors would like to see or why they would need to have this kind of information,” he said.

Another challenge, pointed out by SSGA, is that there is little correlation between the different third-party ESG scores.

Reznick explained that the messiness of data is because ESG integration in the investment process is relatively new.  Fixed income has an even shorter track record than equities. “It is still very early days for both equity and credit guys.”

Performance questions

He added that equity and credit investment opportunities can to a large extent undergo the same ESG assessment.

“ESG factors can have a material impact on cash flows and thus enterprise value, which has an impact on both credit risk and implied equity values,” he said.

But from a returns perspective, opinions on ESG integration are mixed. Applying an ESG assessment to equities is believed to increase the chances of selecting outperforming companies, while in fixed income, a green bond has no performance advantage vs a traditional bond, according to Julien Bras, portfolio manager at Allianz Global Investors.

“The characteristics of a green bond do not have a sufficient weight, compared to other technical factors, to make performance higher or lower versus standard bonds,” Bras said.

Reznick, however, said academic and financial research shows that show that ESG integration for fixed income is “minimum neutral and most likely positive.

“Multiple studies find a connection between credit spread and ESG quality and that means managing ESG risk can enhance your performance.”

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