The market for ESG bonds developed more slowly in Emerging Markets (EM) vis-à-vis Developed Markets (DM). Not coincidentally, 2016 - the year after the Paris Agreements and the UN SDGs - marked the most notable growth in ESG issuances. Current aggregate EM issuance (Government and Corporate in all currencies) stands at around USD 215.4bn or slightly less than 18% of the total outstanding ESG Fixed Income debt outstanding.
Asia dominates the ESG Corporate bond market, and China dominates in the same way (23% market share) that it does in the overall Emerging Market Fixed corporate bond market (25% in the JPM CEMBI Broad).
Furthermore, at 19% and 16% of the EM corporate ESG market, Korea and India have significantly higher market shares than they do in the traditional JPM CEMB Broad index, where their respective shares are 3.6% and 4.5% respectively.
Within Asia, Indonesia and the Philippines also command a much bigger market share in the EM corporate ESG market than in the JPM CEMB Broad index (1.4% and 1.7% respectively)
Governance factors dominate the rhetoric for EM sovereigns and corporates
Although compared to their DM counterparts, EM is playing the catch-up game, strides are being made by several countries within EM. While higher ESG scores go hand in hand with tighter CDS spreads; in EM the average spread difference between the top rated versus bottom rated is evident, owing to lower “E” scores. “S” and “G” factors - in particular “G” - tends to have a more pronounced impact on EM vis-à-vis DM.
Given how poorly EM Sovereigns fare in ESG performance versus DM Sovereigns, it is perhaps not surprising that one sees similar trends in the companies themselves.
In a recent study, Nutmeg research assessed corporations globally using MSCI scoring.
With respect to Governance, EM fared extremely poorly with scores of 3.9 (out of 10) versus Europe’s 5.8 and MSCI ACWI average of 5.3. Further, both Moodys and Fitch have found Governance to be the most frequently cited consideration in EM rating actions, by far.
Family Ownership a hallmark of Emerging Markets
EM corporates fare poorly when measured on Governance with a variety of shortcomings including lack of independent board or management, poor shareholder rights and inadequate disclosure among the various weaknesses. However, these are merely symptoms. One of the key factors in sub-par governance is ownership concentration.
For example, in Asia, one finds in a number of countries (Indonesia, Philippines, Malaysia et al) that the majority of the market value of the country stock exchange is owned by a handful of families.
Figure 28. Ownership concentration at company level, as of end 2018
Note: The figures shows average percentage owned by the single largest and 3 largest holders. Calculations are based on ownership data for the 100 largest listed companies in each market.
Source: OECD Capital Market Series dataset, FactSet, see Annex for details
Does better ESG lead to better returns in EM Fixed Income?
If one assumed that “walking the ESG walk” meant superior returns/alpha in EM Fixed Income investing - one would be wrong. We are unaware of any substantive, credible evidence that points to a positive relationship between higher ESG scores and alpha.
In fact, comparing Emerging Market Corporate Bonds (JPM CEMBI Broad Diversified) and Emerging Market Sovereign Bonds (JPM EMBI Diversified) with the JPM ESG CEMBI Broad Diversified and JPM ESG EMBI Diversified, one finds that over both the past one and three-year periods, the ESG portfolios actually underperformed slightly. On the other hand, it does not appear that investing solely in labelled (ESG) bonds results in significantly lower returns.
Source: JP Morgan, Bank of Singapore
What is a “Greenium” and does it exist in EM Fixed Income?
The term “Greenium” is used to describe a situation where an ESG bond from an issuer with similar characteristics trades at a premium to its non-ESG counterpart.
There are certainly instances where a clear “Greenium” exists. For example, the recent Klabin’31 Sustainable Bond came at a significant 50 basis point premium to its theoretical fair value versus the existing curve of non-ESG bonds. While there are scattered examples of the existence of a Greenium, it tends to be the rare exception rather than the rule and is often based on technical factors deriving from unique characteristics of the issuer or structure.
Furthermore, as the ESG market grows and matures we would expect any “Greenium” to be eroded over time.
If there is no economic benefit from investing in those companies with superior ESG performance, then what will drive further adherence to making ESG an important consideration in investment allocation? We would put the answer to this query in two disparate rationales:
1. Relationship between ESG and performance will grow over time
While carbon neutrality in 2050 may seem far away, to achieve this objective, will need a multi-year process that will require significant changes in corporate/individual behavior, if not now, certainly in the not too distant future. Looking forward, investing in accordance with ESG criteria may help investors avoid companies vulnerable to refinancing risk and downgrades. This in turn will be reflected in lower costs of capital for those companies with superior ESG profiles.
Standard & Poor’s has created a rating continuum that ranks companies based on their potential environmental exposure. Over time, companies that find themselves on such lists will likely face increased scrutiny. If they do not have well-defined and well-articulated plans to adapt to global environmental change, the market may penalize them with higher costs of capital.
2. Image and altruism
The hallmarks of ESG, i.e. a cleaner and more sustainable earth, workforce health and safety, diversity, better governance et al. Certainly one would be hard pressed to find someone who would not admit that these are worthy goals, almost like “Motherhood and Apple Pie”.
As with sin bonds (Tobacco, Gambling, Defense etc.) over the years, there will be a core group of investors who will view ESG from an “exclusionary” perspective, and will simply not invest in those companies who do not meet and uphold their respective “values.”
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