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Riding the ESG debt wave and what it means for investors

08 June 2022

As ESG has taken centre stage in investment processes, the industry has responded with a wave of innovation. This has included a surge in ESG debt issuance. According to research from Bank of America, the first half of 2021 saw $250bn of these bonds being issued – outstripping the $200bn issued in the whole of the preceding year.

Figures like this may appear positive on the surface, but at Apex Group we recognise this can raise new challenges for investors. We covered these in a recent webinar for Responsible Investor – which you can watch on demand here – but it is worth picking out the key issues we see as vital for investors to keep in mind.

First, it is clear the opportunity this type debt poses for investors. The world has seven years of ‘carbon budget’ left to reach a critical inflection point if we are to avoid an irreparable level of climate change damage. This poses a huge financing need, with McKinsey Sustainability research putting the required cost at $9.2trn a year during that time. Issuance of more ESG debt can unlock capital, incentivise ESG performance and support the projects that need it most – while hopefully producing risk-adjusted returns for investors.

However, this wave of issuance is providing challenges that will inevitably need to be tackled by investors. This is largely to do with the sheer scale, and speed, of this tidal wave of issuance. For one, ESG debt is increasingly being met with scrutiny from commentators and regulators with concerns about greenwashing being voiced. Indeed, there is a need for greater regulation in this field, and until this happens some investors may be wary of being exposed to potential reputational risks. Tellingly, the Global Sustainable Investment Alliance recently revealed EU managers stripped the ESG label from $2trn of assets in the run up to the SFDR launch in March 2021.

Regulations are coming but it is important for this debt to prove its additionality. By this we mean, how can this debt stimulate real, meaningful change while providing a return? Data is key here.

Any investment decision-maker requires the best data they can get to inform what they do next. Decisions around ESG debt are no different but currently, there are shortfalls of data in this field - both in terms of quality and quantity. This heightens the need for companies to address their knowledge and resource gaps as well as time constraints – issues exacerbated by a lack of standardisation in the market.

Improving integrity of data here will play a vital role in moving decisions away from assumptions and estimations. This is also important for emphasising the materiality of the financial benefits of investing in this debt.

Fortunately, this is something we are already seeing signs of. For instance, with the EU’s SFDR, which is a positive step in the right direction for driving sophistication across the market. We hope this progress will continue and raise the minimum expectations of data quality and coverage in the market. Here, quality can meet the quantity of issuance we are already seeing. The ambition meets action.

Across the market there is a clear fear of missing out, but data collection must catch up. This is evident in the friction around greenwashing and increased scrutiny. Competition is both a positive catalyst here, but also has the potential to interfere in how capital is channelled towards the most important ESG goals.  

As the market matures this will, of course, mean greater complexity and cost. We see a lot of ESG debt instruments being issued with just one measurable KPI. This will be very different in the future as the market becomes more sophisticated. And we are already seeing this change.

These issues will continue to raise challenges for investors, but we are encouraged by the progress we are seeing. The volume of issuance is exciting, as is the widespread positive sentiment from the market to engage with this – we now need to be careful in this progress is expanded upon, and where ESG debt goes next in its evolution.

 If you want to learn more, get in touch and speak to one of our ESG experts today.

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