In our experience, ESG issues can have a significant bearing on default risk. Consequently, ESG risks are identified as part of our bottom-up credit research process to help manage default risks in bond portfolios.
Analysts must identify the material ESG risks, whether said material risk stems from the E, S or G bucket, and assess how well the company manages these material ESG risks – thus arriving at their overall ESG risk assessment. We have a 5-point ESG risk scale ranging from Very Low to Very High. Along with the ESG risk determination, analysts are required to indicate if these material ESG risks are on an improving, steady or deteriorating trajectory in their research. Risk of asset stranding are also identified where applicable.
ESG risk ratings are reviewed at least annually. Analysts rely on a combination of company engagement, company reports and third party research providers to arrive at their assessment. Of the third party ESG providers, we use Sustainalytics for our Environmental (E) and Social (S) risks assessments and MSCI for Governance (G) assessment. RepRisk is utilised to pick up the number and scale of controversies for a company over a 1-3 year period.
Critically, our ESG risk assessments have an important bearing on proprietary Internal Credit Ratings (ICR) that are assigned to every credit we review, in turn influencing portfolio construction decisions. For example, if it is in the highest risk category “Very High” it has a mandatory one-notch penalty to the ICR than what it would otherwise would be.
The Co-Leads of Credit Research is responsible for ensuring the consistency and quality of the ESG inputs.
Our approach of integrating ESG analysis into the ICR has been in place since 2008.
We annually review and rate our counterparties on a number of factors including ESG. The counterparty review relies on external ESG service providers, analysis from our analysts, and also included a survey of our counterparties where they are not adequately covered by our external providers.
The counterparty review is provided to the counterparties and has been the source of engagement with some counterparties on their ESG performance. The reviews also determine how much and whether we will trade with different counterparties. All other things being equal, a low ESG rating will make it less likely that we will trade with a particular counterparty.