A quarter of ESG-labelled bonds are not sustainable, says Insight Investment

Global asset manager criticises weak incentives in SLB structures, while HSBC backs calls to reject use of ESG ratings as KPIs.

Insight Investment rates a quarter of ESG-labelled bonds as unsustainable, according to the £867 billion ($1.05 trillion; €1.02 trillion) manager’s head of responsible investment.

Speaking at the Oxford Sustainable Finance Summit, Robert Sawbridge said that a quarter of use of proceeds and sustainability-linked bonds that Insight assesses fall into the “red” category of its evaluation framework.

The firm recently switched from a traffic light system – with bonds classified as either green, amber or red – to a classification of dark green, light green and red after clients raised queries over why the manager was investing in “amber” bonds. Sawbridge said that dark green bonds “tick 90 percent of our boxes”, whereas light green was around 70 percent. With red bonds, “you’ve maybe ticked less than 50 percent”.

“There’s 25 percent of use of proceeds and sustainability-linked structures that we don’t think are particularly well thought through, and we wouldn’t categorise as being impactful in terms of what they’re trying to achieve,” Sawbridge said.

Insight has seen several examples where “it feels like the bank has gone to them and said ‘if you issue a green bond or an SLB, we can bring down your cost of financing’ and they go ‘okay, great, what’s the minimum we need to do?'” Sawbridge said. He cited a recent deal from a US utility that was looking to fund renewables projects. “Everything about the programme in terms of how they put it together we felt was just a bit below par” – including the fact that the issuer did not feel the need to obtain a second party opinion.

As the market grows, managers are increasingly scrutinising deals’ sustainability credentials. NN IP’s Isobel Edwards recently told Bloomberg that the asset manager was rejecting around 30 percent of ESG deals, while Triodos Investment Management made headlines when it avoided the UK’s inaugural green gilt due to its inclusion of blue hydrogen and carbon capture and storage.

Sawbridge also raised concerns over the emergence of 25 basis points as the standard step-up for sustainability-linked bonds.

While acknowledging that Enel is “a leader in the space”, Sawbridge said the additional costs faced by the Italian utility for missing its targets on one 2029 SLB would amount to €3 million. Enel’s total interest costs in 2020 were €2 billion.

“The concept that 25 basis points on a single bond is enough to incentivise behaviour is just not correct,” said Sawbridge. “We don’t really think the incentives are there unless the issuer builds out a full SLB curve, in which case cumulatively that might add up.”

Farnam Bidgoli, global head of ESG solutions at HSBC, echoed Sawbridge’s concerns, calling the 25 basis point step-up “arbitrary”. As she noted, even if the figure made sense for Enel, the first issuer to use the format, companies with varying credit profiles have come to market since then – “so hanging on to 25 basis points is a bit strange”.

A poor rating for ratings links

Both Sawbridge and Bidgoli also came out against tying coupons to firm’s ESG ratings in sustainability-linked deals.

Sawbridge said Insight was strongly opposed to the concept as ratings are “more about how companies manage their sustainability risks, they’re not about sustainability impacts”.

Meanwhile, HSBC is pushing clients not to tie their financing costs to ESG ratings, especially on the loan side, according to Bidgoli. She noted that ESG ratings are based on as many as 70 different indicators and many ratings are scaled according to sector-wide performance, so an issuer can see an up or downgrade “without anything actually changing on their side”.

Instead, issuers should look at material topics from a sectoral perspective, and look at indicators that will address those, she said.

The International Capital Markets Association (ICMA) said that ESG ratings were acceptable as a KPI in its updated guidance on SLBs earlier this year. However, it added that issuers should explain why an ESG rating is the best indicator to reflect their core business ESG challenges, and ESG ratings were not included in its database of 300 suggested KPIs for sustainability-linked deals.