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J.P. Morgan Asset Management

PRI reporting framework 2020

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You are in Direct - Fixed Income » ESG incorporation in actively managed fixed income

ESG incorporation in actively managed fixed income

Implementation processes

FI 01. Incorporation strategies applied

Indicate (1) Which ESG incorporation strategy and/or combination of strategies you apply to your actively managed fixed income investments; and (2) The proportion (+/- 5%) of your total actively managed fixed income investments each strategy applies to.
SSA
0 Screening alone
0 Thematic alone
95 Integration alone
0 Screening + integration strategies
5 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%
Corporate (financial)
0 Screening alone
0 Thematic alone
90 Integration alone
10 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%
Corporate (non-financial)
0 Screening alone
0 Thematic alone
90 Integration alone
10 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%
Securitised
0 Screening alone
0 Thematic alone
95 Integration alone
5 Screening + integration strategies
0 Thematic + integration strategies
0 Screening + thematic strategies
0 All three strategies combined
0 No incorporation strategies applied
100%

01.2. Describe your reasons for choosing a particular ESG incorporation strategy and how combinations of strategies are used.

We expect the issuers in which we invest our clients’ money to conduct business in a sustainable manner and to demonstrate high standards. We are committed to delivering strong risk-adjusted returns for our clients, and we believe that one of the drivers of that performance over the long term is an assessment of the ESG practices of the issuers in which we invest. As such, we explicitly and systematically take into consideration relevant and material ESG issues, alongside other market risk factors, as a fundamental part of our sound risk management and a core part of our fiduciary responsibility.

In the Global Fixed Income, Currency & Commodities and Global Liquidity groups (GFICC), each sector team integrates ESG considerations throughout their investment process. Importantly, this assessment is incorporated into our existing common research framework, in which every investment decision is backed by fundamental, quantitative valuation and technical analysis. While each sector team takes a slightly nuanced approach to ESG integration – according to their existing investment process and taking into account the differences of each market – we have a consistent approach to ESG integration in GFICC which spans three pillars: proprietary research, engagement and portfolio construction.

01.3. Additional information [Optional].

Proprietary research forms the foundation of our approach to ESG integration. With over 60 dedicated research analysts, we have the expertise to make informed, judgmental decisions on the ESG profile of each issuer in which we invest. While we consider ESG data from third-party providers, this is merely a reference point and does not dictate our views.

Even though we do not have voting rights as bond investors, engagement is a key part of our approach to ESG integration. We regularly meet with company management and government officials, pressing them on topical issues and encouraging them to adopt best practices. In addition, we also aim to have a positive influence on the industry by participating in industry forums and regularly consulting with third-party providers with the aim of improving their data. We also collaborate closely with our Investment Stewardship team on firm-wide engagement efforts.

We recognise that our clients have different objectives. Therefore, we see integration as a foundation for a broader sustainable investment platform, which also includes screening, positive tilt and thematic capabilities:

  • We manage negatively screened strategies for a variety of clients and a thematic Municipal Debt strategy. In Q4 2019, we also launched an explicitly sustainable flexible global bond which incorporates positive tilt.
  • We invest in Green Bonds in traditional portfolios where prospective risk-adjusted return is attractive and have the capability to manage dedicated Green Bond portfolios for thematic investors. We have developed an internal governance process for Green Bond classification which encourages issuers to adopt common standards and improve disclosure practices.
  • In all portfolios, we adhere to legally mandated exclusions such as controversial weapons restrictions and US OFAC sanctions-based restrictions.

FI 02. ESG issues and issuer research (Private)


FI 03. Processes to ensure analysis is robust

03.1. Indicate how you ensure that your ESG research process is robust:

specify description

          Please see response below in 3.3.
        

03.2. Describe how your ESG information or analysis is shared among your investment team.

03.3. Additional information. [Optional]

ESG analysis and research is visible on our centralised technology platform, Spectrum, and is reviewed on a regular basis.

Quantitative Analysis: Third-party provider ratings are displayed for each issuer in our proprietary portfolio management system, which allows investors both to customise views in order to understand portfolios’ ESG exposures at various aggregated levels (such as country, credit quality, sector and total portfolio) and to observe changes in portfolios’ ESG scores over time.

Qualitative Research:

  • The Research Notes application within Spectrum, which is the database housing all of our proprietary research, ensures that all written research reports are stored centrally and visible to investors across the platform.
  • Each research note contains a separate section for ESG, and every analyst makes a qualitative ESG assessment when conducting research.
  • Specific ESG notes or engagement reports can be tagged as such within Spectrum, allowing for a search function to enable easy access to ESG-related activity.

(A) Implementation: Screening

FI 04. Types of screening applied

04.1. Indicate the type of screening you conduct.

Select all that apply
Corporate (financial)
Corporate (non-financial)
Securitised
Negative/exclusionary screening
Positive/best-in-class screening
Norms-based screening

04.2. Describe your approach to screening for internally managed active fixed income

We adopt a positive engagement approach to ESG integration: generally, specific sectors or securities are not automatically excluded from portfolios unless the following conditions apply:

  • The product requires the incorporation of negative screening
  • A client has specifically requested exclusions in a separate account
  • Local laws or regulations apply

We uses several third-party data providers to screen when exclusions apply – the relevant information feeds directly into our internal guidelines system, allowing automatic exclusion from portfolios where required.

Furthermore, in 2019 we launched an explicitly sustainable version of one of our flexible global bond strategies, called the JPMorgan Funds – Global Bond Opportunities Sustainable Fund. This strategy invests across all fixed income sectors (SSA, corporate and securitised) and applies ESG integration, exclusions (both norms- and values-based) and a positive tilt screening. The launch of this strategy exhibits our capability in managing a variety of sustainable styles across all types of bond markets.

04.3. Additional information. [Optional]

Our systems receive the screening data regularly and systematically prevent investments which do not meet client and/or portfolio guidelines. Criteria can be based on business involvement, impact monitoring and other indicators when requested by clients in segregated mandates. These include but are not limited to: environmental controversy, global defence/weapons, animal abuse, human life, nuclear, traditional sin restrictions, country involvement and violations of laws and regulations. For some ESG portfolios, screening takes place based on a severity based rating scale, for example, a 5% revenue threshold.

We also manage client accounts seeking positive social benefit using a best-in-class approach, buying corporates with ESG scores of average or better and investing in SSA and securitized issues on thematic grounds including Green Bonds and securitized bonds focused on providing financing for low income housing, for example.


FI 05. Examples of ESG factors in screening process (Private)


FI 06. Screening - ensuring criteria are met

06.1. Indicate which systems your organisation has to ensure that fund screening criteria are not breached in fixed income investments.

Type of screening
Checks
Negative/exclusionary screening
Positive/best-in-class screening

06.2. Additional information. [Optional]

Where ESG factors are coded within guidelines, they are regularly reviewed by standard oversight practices.


(B) Implementation: Thematic

FI 07. Thematic investing - overview (Private)


FI 08. Thematic investing - themed bond processes

08.1. Indicate whether you encourage transparency and disclosure relating to the issuance of themed bonds as per the Green Bonds Principles, Social Bond Principles, or Sustainability Bond Guidelines..

          Please see our response on FI 07.2 and FI 08.3
        

08.2. Describe the actions you take when issuers do not disburse bond proceeds as described in the offering documents.

If this situation were to occur and we were made aware of the issue we might:

  • Notify portfolio managers
  • Engage with the issuer to understand the circumstances
  • Manually override the thematic designation of this bond issue for holdings within our traditional portfolios and flag our concern
  • Evaluate whether this bond issue in thematic portfolios should be potentially sold (though such sale is not required by the Municipal Bond Strategy)

08.3. Additional information. [Optional]

Municipal Bond Strategy:

We often engage directly with issuers when circumstances warrant or an opportunity exists. More specifically, we speak directly with issuers when there are significant developments that impact credit quality. We also participate in industry conferences and deal roadshows, where we have the opportunity to speak directly with management.  Lastly, we actively participate in ESG investment related industry conferences for both issuers and investors.

The level of direct issuer engagements varies by sector as well as the credit quality of the issuer.  When engaging an issuer, we address credit issues as well as specific ESG issues when relevant. For example:

Governance:

  • We continually encourage issuers to provide better and timelier disclosures.
  • In our engagements with issuers that have litigation concerns, we seek to understand the issues and inquire about remediation and prevention plans for future litigation risks.
  • In conversations with issuers on retiree liabilities, pension funding plans and pension investment policies, views on the plans' legal protections are considered.
  • In our conversations with infrastructure issuers, we often discuss resiliency plans (i.e., anti-seismic improvements and insurance policies) against natural disasters.
  • In our conversations with charter school borrowers, management succession planning is often addressed.  Many schools were founded by an individual or small group of individuals who shared a common belief regarding the particular mission of a school.  In cases where management or members of the board are original founders there is often a question about continuity of the school’s mission once some or all of those individuals leave. 

Environmental:

  • In conversations with project-financing issuers (e.g., toll roads), we often discuss the project’s environmental study and how the sponsor plans to meet the various environmental requirements.
  • Many charter school facilities are either repurposed existing facilities or new construction, often on property that formerly was used for unrelated purposes or is located in a high-density urban area.  Therefore, we are raising more questions to management regarding previous environmental remediation or
  • In conversations with issuers that face environmental challenges (e.g., sea level rise), we have discussed their general and capital planning against these challenges. 

Social:

  • In our conversations with mission-oriented not-for-profit issuers (e.g., cultural institutions, research laboratories, and retirement communities), we seek to understand the social mission behind an issuer’s operating principals and capital financing objectives.

While we strive to engage issuers to the extent possible, we feel it is important to note that the municipal industry is not as advanced as the corporate sector with respect to engagement on ESG issues.  This is mainly the result of the breadth of issuers in municipal investment universe.  With over 50,000 issuers in the Barclays Municipal Bond and High Yield Municipal Bond indices (and many out of index issuers), the issuers in the municipal market are very diverse with respect to both size and sophistication, particularly in regard to financial and other disclosure.  With many small issuers, engagement is a challenge and thus our engagement as described above is more typical of more sophisticated issuers.  However, we continually communicate to issuers, rating agencies, bankers, data vendors and other investors, the need for better ESG disclosure and data within the sector.

Green Bond Strategy:

Our Green Bond investors have continued to engage with multiple issuers in the past year to encourage them to adopt Green Bonds Principles to support standardization within the space.

As we continue to develop a robust Green Bond framework, our investors and analysts are engaging issuers prior to bringing new Green Bonds to the market.  Credit analysts are evaluating Green Bond compliance with both industry practices as well as the developing internal framework.  On several occasions our analysts have reached out to issuers to express concerns over use of proceeds and segregation of proceeds issues that were not in compliance with Green Bond Principles.

We have ongoing dialogue with existing and potential Green Bond issuers. We expressed a need for additional standardization within the marketplace and communicated that we would like to see entities establish Green Bond Frameworks consistent with the Green Bond Principles established by the ICMA.  We have communicated to issuers that we expect any new Green Bond that comes to the market to, at least, meet Green Bond Principles standards.  We have also communicated our internal Green Bond Framework and approach to evaluating and labelling green bond issuers and issues.

We continue to advocate the benefits of issuing larger (benchmark-sized) green bond programs (when applicable) to the market. We communicated to the issuers and underwriters that we estimate liquidity costs associated with deviations from typical benchmark issuance size. We factor this liquidity cost into our overall total return framework when evaluating the attractiveness of new issuance. We communicated/quantified the benefits of bringing a traditional (general purpose) benchmark size for a green issuance. We highlighted the improved secondary liquidity profile, which we believed would enhance the development of the green market and more easily identify the value propositions embedded within the green bonds.  We have established a secondary valuation metric for liquid DM issuers which looks at the value behavior of green bonds against general purpose bond curves historically.


FI 09. Thematic investing - assessing impact

09.1. Indicate how you assess the environmental or social impact of your thematic investments.

          Our sustainable strategy in municipal bonds uses a proprietary framework to measure the % of portfolios/benchmarks invested in assets that provide social or environmental benefits.
        

09.2. Additional information. [Optional]


(C) Implementation: Integration

FI 10. Integration overview

10.1. Describe your approach to integrating ESG into traditional financial analysis.

We have consistently considered ESG factors as part of our investment process. Broadly speaking, we do not apply exclusions, but over the past 3 years we have formalised our approach to integration. We have developed specific ESG initiatives and enhanced our systems to support ESG integration throughout the investment process. Our approach to ESG integration can be considered across three pillars:

Proprietary Research:

  • We have over 68 career research analysts dedicated to thoroughly researching every aspect of an investment, including ESG factors where material and relevant.
  • Analysts have access to third-party data within our research database, which is displayed for each issuer in various ways (analysts are able to track individual “ESG pillar” scores, as well as observe changes over time).
  • This quantitative data is a supplement to, and not a dictator of, our analysts’ view of an issuer’s ESG profile. Our analysts will form their own view based on their research and judgement, and this will be articulated in a written research report, which contains a specific section for ESG comments.
  • Recognising that ESG differs by sector, we have developed a materiality matrix to raise and maintain awareness of the potential ESG factors to consider for each team. Listed by asset class and subsector, it specifies the materiality of E, S and G using a traffic light system (e.g., red for highly material), and provides comments for each sector covering key issues to be aware of. This is updated annually and acts as a baseline of understanding across the platform, and also helps to direct analysts’ research and portfolio managers’ oversight toward the most material areas. It is available to all investors as a reference in our research database.

Engagement:

  • As bondholders, although we do not carry voting rights, we engage on a wide range of ESG issues with a variety of market participants. Our large scale and position within the asset management industry allows us significant representation across asset classes: we often conduct engagement at a firm-wide level, or with our equity counterparts where our specific company interests align.
  • Our investors carry out ESG engagement in various ways:
  • Individual issuers. We carry out over 2,000 meetings with issuers per year, across both company management and government officials. Our investors will raise issues they have identified as material and relevant, including ESG concerns, in an effort to positively influence issuers to adopt best practices.
  • Industry boards and forums. We have board representation on industry bodies, such as the Edison Electric Institute, and are thereby able to encourage closer co-operation among issuers on key ESG initiatives.
  • Ratings agencies. We have worked with rating agencies to promote better corporate behaviour in certain sectors, and to encourage co-operation between legislators, issuers and other industry bodies.
  • Data providers. We work closely with data providers such as MSCI and ISS Ethix in order to improve the overall coverage of the fixed income universe, which currently lags other asset classes, and to ensure data is accurate and timely.
  • The results of our ESG engagement will be reflected in the research report produced by analysts, and will feed back into the overall view of an issuer, thereby implicitly impacting investment decisions.

Portfolio Construction:

  • All quantitative metrics and qualitative assessments are housed in our common technology platform, to ensure full transparency and access across all investors.
  • Portfolio managers have a daily view of their exposure to the risk associated with ESG factors. Each holding’s score (using third-party data at this stage) is visible in PRISM, our portfolio management system, and can be viewed in a customisable window depending on the nature of the portfolio.
  • With our analysts conducting in-depth bottom-up research of each bond, continual monitoring is then required in portfolios to understand the ongoing ESG profile of a portfolio. Our independent risk management team has developed periodic risk reports, sent directly to portfolio managers, to enable them to understand the ESG risks to which they are exposed, and to identify potential outliers in terms of ESG scores.

We have also started collaborating with our centralized Investment Stewardship team as well as Global Equities team in sharing corporate engagement meetings and exchanging views on ESG.

10.2. Describe how your ESG integration approach is adapted to each of the different types of fixed income you invest in.

SSA

GFICC manages holdings in developed and emerging market sovereign bonds, agencies and supranational agencies, and municipal debt. The teams perform fundamental research which is supplemented with access to MSCI ESG data and research reports where available. Based on the team's holistic review of the issuer and market conditions, fundamental, quantitative and technical factors in the marketplace are considered to arrive at an investment decision. These teams are all fully ESG integrated.

In developed market sovereigns, we incorporate ESG factors as part of our regular analysis of sovereign creditworthiness. We believe that sovereign credit risk, including risk from ESG factors, is most pronounced for sovereigns issuing without the support of a domestic central bank. We consider governance issues to be the most material ESG drivers for developed market government bonds at present, followed by social and environmental issues. Our investment decisions are based on our assessment of sovereign creditworthiness, which incorporates both quantitative analysis and qualitative factors such as the impact of political developments on the fiscal and economic outlook. Our quantitative analysis consists of a scorecard process, in combination with a wide range of other factors including valuation and the balance of bond market supply and demand. The scorecard process involves assessing and ranking each country’s standing on a variety of factors, including those specifically related to environmental, social and governance topics such as unemployment rate, government deficit, government debt, control of corruption, World Governance Indicator, demographics, education levels, energy intensity of GDP, renewable energy, energy imports, competitiveness and ease of doing business.  We draw from a wide range of data tools and indicators to capture these ESG dynamics,  including the World Bank's World Governance Indicators and survey measures of the quality of governance such as that conducted by Transparency International.

Our analysis of EM sovereign debt consists of several proprietary tools to assess a country’s ability and willingness to repay its debt, including our Country Fundamental Index (CFI) and Country ESG Index (CESGI). The CFI model provides an independent, objective measure of creditworthiness (by incorporating a number of fundamental indicators spanning solvency, liquidity and structural factors) that is used to calculate fair value spreads. The CESGI model provides a holistic quantitative assessment of ESG factors that is used to calculate an ESG-adjusted fair value spread. The CESGI is constructed by considering over 30 ESG indicators and focusing on those which have more significance in explaining the difference between country spreads and CFI-implied fair value. These factors include: carbon emissions, vulnerability to environmental risks, poverty, gender equality, ease of doing business, corruption and short-term political risks. The output of these quantitative models is supplemented with qualitative comments, informed by analyst research and regular country visits to meet with central bankers, government officials and local analysts.

We integrate ESG analysis into our municipal debt investment process, based on materiality, relevance, and the availability of information, to identify potential idiosyncratic ESG risks or opportunities. Securities are selected based on relative value and internal credit risk assessment, which incorporates our ESG factor analysis. Analysts communicate the credit assessment to portfolio managers, who then consider noted ESG factors into relative value decisions. More specifically, analysts evaluate relevant and material ESG factors in credit research process based on available information, keeping in mind factors that are unique to municipal obligors. ESG factors for municipal obligors are articulated in a materiality matrix for each sector and have both commonality and differences when compared to corporate obligors. In certain circumstances, the analyst also evaluates the use of proceeds where use of proceeds are deemed by the advisor to provide positive social or environmental benefits. This assessment is made for portfolios that have mandated a preference for positive ESG impact. Similarly, analysts identify securities where the ESG risk is determined to create material, negative credit risk, so that the firm can measure such risk in portfolios. Please see section 12 for more detail on the types of ESG risk factors we consider throughout our investment process.

Corporate (financial)

Our Corporate Research teams, including investment grade, high yield and emerging markets, are fully ESG integrated.

For Corporate (financial) issuers, ESG risks are systematically considered as part the bottom-up fundamental analysis of corporate issuers. As part of the in-depth fundamental research, credit analysts analyze all aspects of a company, including how ESG risks and opportunities are currently affecting a company's cash flows as well as how cash flows may be impacted in the future. If the analyst believes that the ESG factors are material and may impact issuer risks, the analysis will be reflected in analyst credit opinions.

Analysts focus on material investment risks including ESG factors. Credit analyst proprietary fundamental research is supplemented with access to MSCI ESG data, research reports and company engagements. EM credit analysts supplement research by consulting with companies they cover to answer a list of ESG related questions. This process particularly aids in analysis where 3rd party ESG providers do not furnish rankings. This is done in collaboration with equity analyst colleagues where coverage overlaps and information barriers allow. Based on their holistic review of the issuer fundamentals and market conditions, IG credit and EM credit analysts perform a proprietary ranking process. Portfolio managers have access to both the proprietary analyst issuer ranks as well as third party ranks, including MSCI. Analysts also have the ability to explain ESG's role in a particular issuer view in the "ESG Comments" section of research communication. Portfolio managers take this information into account to assess the fundamental, quantitative and technical factors in the marketplace to arrive at an investment decision. In addition, IG credit and EM portfolio managers regularly review and discuss portfolio holdings with low and high ESG scores at regular meetings and this fosters ESG collaboration with credit analysts. Please see section 12 for more detail on the types of ESG risk factors we consider throughout our investment process.

 

Corporate (non-financial)

Our Corporate Research and Investment teams, including investment grade, high yield and emerging markets, are fully ESG integrated.

For Corporate (non-financial) issuers, ESG risks are systematically considered as part the bottom-up fundamental analysis of corporate issuers. As part of the in-depth fundamental research, credit analysts analyze all aspects of a company, including how ESG risks and opportunities are currently affecting a company's cash flows as well as how cash flows may be impacted in the future. If the analyst believes that the ESG factors are material and may impact issuer risks, the analysis will be reflected in analyst credit opinions.

Analysts focus on material investment risks including ESG factors. Credit analyst proprietary fundamental research is supplemented with access to MSCI ESG data, research reports and company engagements. EM credit analysts supplement research by consulting with companies they cover to answer a list of ESG related questions. This process particularly aids in analysis where 3rd party ESG providers do not furnish rankings. This is done in collaboration with equity analyst colleagues where coverage overlaps and information barriers allow. Based on their holistic review of the issuer fundamentals and market conditions, IG credit and EM credit analysts perform a proprietary ranking process. Portfolio managers have access to both the proprietary analyst issuer ranks as well as third party ranks, including MSCI. Analysts also have the ability to explain ESG's role in a particular issuer view in the "ESG Comments" section of research communication. Portfolio managers take this information into account to assess the fundamental, quantitative and technical factors in the marketplace to arrive at an investment decision. In addition, IG credit and EM portfolio managers regularly review and discuss portfolio holdings with low and high ESG scores at regular meetings and this fosters ESG collaboration with credit analysts. Please see section 12 for more detail on the types of ESG risk factors we consider throughout our investment process.

Securitised

Our Securitized Research and Investment Teams are fully ESG integrated.  Conducting ESG analysis within the securitised sector is important as these factors have the ability to impact risk-adjusted returns. However, there are challenges to performing this research which are unique to the securitised space. There is a significant lack of coverage from third-party ESG data providers, so the ratings systems that are prevalent in the equities, corporate and sovereign bond markets are not available. The inherent nature of a securitisation (packaging together multiple loans), the potential complexity of the structures and the varying disclosure requirements also contribute to why the market has been slower to formally incorporate ESG considerations.

From a top-down perspective, our securitised team, together with our sovereign team, assesses the macroeconomic environment so as to understand the impact of interest rate moves and investor sentiment on the overall securitised market. They also work together to comprehend country specific dynamics, ensuring that we understand the environment of each issuer in which we invest. Additionally, the securitised investors collaborate with the corporate bond team to identify industry trends that may influence the underlying collateral. From a bottom-up standpoint, we conduct research on both the security’s underlying collateral and the deal structure. The analysis of the collateral focuses on the quality of the underlying receivables and the likelihood that future cash flow payments will ultimately be received. The primary focus of assessing the deal structure is to review the structural factors which can alter the payments flowing from the collateral to different tranches in the deal to better understand each security’s expected total return under different prepayment or expected loss scenarios.

Environmental, social and governance factors are key components of both the collateral and structural analysis we perform, as they can have a notable impact on future cash flows. We have developed a proprietary materiality matrix to serve as the foundation of integrating these ESG considerations into our investment process. By highlighting the sources of the most material ESG risks by sub-sector, this matrix serves to guide and direct investors’ research efforts. Please see section 12 for more detail on the types of ESG risk factors we consider throughout our investment process.

10.3. Additional information [OPTIONAL]


FI 11. Integration - ESG information in investment processes

11.1. Indicate how ESG information is typically used as part of your investment process.

Select all that apply
SSA
Corporate (financial)
Corporate (non-financial)
Securitised
ESG analysis is integrated into fundamental analysis
ESG analysis is used to adjust the internal credit assessments of issuers.
ESG analysis is used to adjust forecasted financials and future cash flow estimates.
ESG analysis impacts the ranking of an issuer relative to a chosen peer group.
An issuer`s ESG bond spreads and its relative value versus its sector peers are analysed to find out if all risks are priced in.
The impact of ESG analysis on bonds of an issuer with different durations/maturities are analysed.
Sensitivity analysis and scenario analysis are applied to valuation models to compare the difference between base-case and ESG-integrated security valuation.
ESG analysis is integrated into portfolio weighting decisions.
Companies, sectors, countries and currency and monitored for changes in ESG exposure and for breaches of risk limits.
The ESG profile of portfolios is examined for securities with high ESG risks and assessed relative to the ESG profile of a benchmark.
Other, specify in Additional Information

11.2. Additional information [OPTIONAL]


FI 12. Integration - E,S and G issues reviewed

12.1. Indicate the extent to which ESG issues are reviewed in your integration process.

Environment
Social
Governance
SSA

Environmental

Social

Governance

Corporate (financial)

Environmental

Social

Governance

Corporate (non-financial)

Environmental

Social

Governance

Securitised

Environmental

Social

Governance

12.2. Please provide more detail on how you review E, S and/or G factors in your integration process.

SSA

Quantitative sovereign fundamental scores are an important metric considered in our integration process. Countries are scored across a range of drivers of sovereign creditworthiness. These drivers include unemployment rate, government deficit and debt, control of corruption and World Governance Indicator, WEF Competitiveness and Ease of Doing Business Index, renewable energy, and education. ESG factors are also assessed continuously on a qualitative basis. In developed market sovereigns, the most important quantitative governance metrics we consider are those related to sound fiscal management, and in particular the level and prospects for government debt and deficits, and the components of deficits, including separating temporary and cyclical factors from structural factors. We also consider the various metrics brought together in the World Bank's World Governance Indicators, as well as survey measures of the quality of governance, such as that conducted by Transparency International. From a qualitative perspective, the most important factors we monitor include elections and political developments, especially in as much as they signal a change in fiscal policy or the growth outlook. Social factors play a role in our economic analysis of sovereigns to the extent they impact our view on economic growth or inflation.

For Emerging Market Sovereigns we have two proprietary models which we use as part of our ESG analysis.

  • Proprietary Country Fundamental Index (CFI) model: Assessment of country’s credit worthiness is based on governance & social factors e.g. growth trends, inflation, liquidity & solvency ratios. Output is a CFI score for each country in the universe. Fair value spread analysis performed for each country.
  • Proprietary Country ESG Index (CESGI) model: The CESGI model provides a holistic quantitative assessment of ESG factors that is used to calculate an ESG-adjusted fair value spread. The CESGI is constructed by considering over 30 ESG indicators and focusing on indicators that have more significance in explaining the difference between country spreads and CFI-implied fair value. These factors include carbon emissions, vulnerability to environmental risks, poverty, gender equality, ease of doing business, corruption, and short-term political risk.

The output of these quantitative models is supplemented with qualitative comments, informed by analyst research and regular country visits to meet with central bankers, government officials and local analysts.

Our analysts also have regular country visits & meetings with government officials (~120/year)

As part of credit risk assessment process, municipal credit analysts consider ESG risk factors.  The team has identified the primary E, S and G factors that are material and relevant to each sector.  Research analysts take both the E, S and G, as well as fundamental factors into account in their analysis.  For electric utilities, for example from the Environmental perspective, we look at pollution abatement and government standards and whether infrastructure meets federal and/or state pollution control requirements.  From a social perspective the costs of pollutants are potentially high and immediate; we also evaluate the sustainability and reliability of supply required.  From a governance perspective we look for transparency, financial controls, independence, fiscal balance and thoughtful capital planning.

Corporate (financial)

As part of their fundamental research analysts analyze all aspects of a company, including how ESG risks and opportunities affect a company's current and future cash flows. Their research is supplemented with access to MSCI ESG data. They also define a materiality matrix to assess the relative importance of E, S and G factors across sectors. For financial issuers, particular focus is placed on Governance and Social concerns. For example, our analysts evaluate overall board independence and important board committee independence from company management. We analyze management compensation practices and alignment with shareholder interests. We also monitor internal risk management practices and internal controls to avoid large scandals or improper activities.

Portfolio managers have access to review analysts ESG comments in Research Notes and MSCI ESG scores in our proprietary portfolio management systems. In addition the PMs receive monthly risk reports to help them to identify both negative and positive ESG outliers in portfolio on an industry adjusted basis.

Corporate (non-financial)

As part of their fundamental research analysts analyze all aspects of a company, including how ESG risks and opportunities affect a company's current and future cash flows. Their research is supplemented with access to MSCI ESG data. They also define a materiality matrix to assess the relative importance of E, S and G factors across sectors as we recognize that different corporate sectors may have different ESG risks. For example, Oil & Gas, Metals & Mining and Utility analysts pay particular attention to the environmental risks associated with carbon and climate change. Meanwhile, our retail and consumer discretionary analysts focus on the social impacts of the labor used along the supply chain. Our media and telecom analysts analyze the governance risks associated with company ownership structures and corporate behavior.

Portfolio managers have access to review analysts ESG comments in Research Notes and MSCI ESG scores in our proprietary portfolio management systems. In addition the PMs receive monthly risk reports to help them to identify both negative and positive ESG outliers in portfolio on an industry adjusted basis.

Securitised

Environmental, social and governance factors are key components of both the collateral and structural analysis we perform, as they can have a notable impact on future cash flows. We have developed a proprietary materiality matrix to serve as the foundation of integrating these ESG considerations into our investment process. By highlighting the sources of the most material ESG risks by sub-sector, this matrix serves to guide and direct investors' research efforts. Some of the most material ESG risks in the securitised space that we assess as part of our ongoing analysis include (but are not limited to) the following:

Environmental

  • Geographic concentration and exposure to extreme weather events: Collateral that is overly exposed to risk prone areas can have a material negative effect on cash flows by causing damage and leading to higher vacancy rates, increased maintenance costs and heightened reputational risk.
  • Carbon footprint and energy, water & waste management: Strong energy management practices can extend the longevity of a building, decrease vacancy rates, attract higher quality tenants and lower maintenance costs.

Social

  • Predatory lending: In addition to the social implications of providing financing to weak borrowers at high interest rates, adverse underwriting practices may lead to heightened regulatory risk and decrease borrowers’ credit scores.
  • Consumer protection laws: Local regulations can impact prepayment speeds and uncertainty around new regulations may be reflected via higher risk premiums.

Governance: The below factors can have a direct impact on the transparency and cash flow profile of a deal.

  • Business ethics of issuer, borrower & trustee
  • Potential for underwriting fraud
  • Conservatorship of the government-sponsored enterprises
  • Regulatory risks
  • Management skill & alignment of interests
  • Transaction & collateral structure
  • Quality of reporting

Portfolio managers have access to review analysts ESG comments in Research Notes. The securitized process considers these risks to help gauge whether current market levels appropriately compensate debt holders for the risks.

12.3. Additional information.[OPTIONAL]


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