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You are in Direct - Fixed Income » ESG incorporation in actively managed fixed income » (C) Implementation: Integration

(C) Implementation: Integration

FI 10. Integration overview

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

Our overall approach to ESG integration is described below, this applies in particular to our Credit Analysis team who are a shared research resource. Detailed information on our other fixed income teams can be found in our annual

Our overall approach to ESG integration is described below, this applies in particular to our Credit Analysis team who are a shared research resource.Our fixed income team have developed their own approach to ESG integration that complement their investment processes. All teams share investment insights, including on ESG information, through our proprietary global investment system ION.

The team believe that ESG issues have a direct impact upon an issuer's risk and therefore its probability of default. As risks turn into liabilities, they will impact costs and cash flow and, eventually affect credit ratings and debt costs. ESG issues can also impact on a sovereign's ability to generate sustainable revenues or potentially increase its future costs, affecting its ability to repay bond holders.

Our fixed income teams have an assessment process for ESG issues, which flows into their view of a particular issuer, whether through the ESG score and Internal Credit Rating (ICR) used by the Fixed Income and Credit teams or the six-factor model used by the Emerging Markets Debt and Asia Fixed Income team.

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

SSA

In Emerging Markets Debt we consider that the potential to deliver risk-adjusted returns is enhanced by the integration of ESG factors. ESG factors are an important part of bottom-up fundamental research and are included in all sovereign credit evaluations. Analysts review a common set of ESG data across all sovereigns, which enhances the objectivity and comparability of assessments. They also determine which ESG factors are market drivers for a given country, and produce a forward-looking assessment identifying where these factors are mispriced by the market. Engagement is used to support this assessment, where possible.

ESG considerations are also an integral part of portfolio construction, specifically as part of a position-sizing discipline. Here, limits to absolute and relative position sizes in portfolios are established by country, based on factors such as credit quality, volatility and liquidity, as well as a qualitative assessment of vulnerability to event risk.

Event risks refer to unexpected events with the potential to materially negatively affect bond prices – and it is our experience that such events are frequently linked to ESG factors. Examples include political succession, social revolutions and severe weather events. To assess the vulnerability of sovereigns to event risk, analysts consider the relative likelihood of them occurring (e.g. political event risks tend to be more frequent in countries 

where policy making is highly centralised), as well as the likelihood of drawdowns in response to the event. Using unexpected severe weather as an example, analysts assess potential downside by examining an economy’s diversification, looking at data such as the share of agriculture within GDP or the importance of agriculture to the balance of payments.

All else being equal, an assessment of higher drawdown vulnerability due to ESG event risks for any country leads to a stricter limit on the size of country portfolio exposure. We believe that this discipline has been a major factor in minimising drawdowns for client portfolios.

Corporate (financial)

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.

Counterparty Reviews

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.

Corporate (non-financial)

For Corporate (Non-financial), the process is the same as for Corporate financial - However, our Global FI team note that special care is shown to issuer provided information (increasingly more common) and how they are addressing environmental and people practices that have been trouble areas in the past.

Securitised

The ESG integration process for Securitized products follows the same process as Corporate ESG analysis (described above), however there are specific ESG issues for Securitized products that are detailed below:

Environmental – there is a risk of geographic concentration of assets to areas which could be affected by environmental issues, e.g. weather events. Pools of assets are assessed to ensure geographic concentration to regions and hence environmental events will not unduly affect the overall financial performance of the Securitized product

Social/Sustainability – origination and servicing processes of underlying pool assets is assessed to ensure that the processes are line with regulatory requirements as well as being undertaken on an ethical basis. This requires physical visits to the offices of the originator and servicer to ensure that the processes are in compliance and are appropriate.

Governance – Various models of ownership are evident across originators of securitized products. They can include listed, unlisted, private equity, individuals, trusts, and non-domiciled entities. Some of these models may provide additional risks for the investors in Securitized products. They can include less investment in technology and staff, higher dividend payments to owners, listed companies may be encouraged by equity owners to undertake activities which could be contrary to investors in Securitized product, and short term corporate strategies which maybe contrary to the investors of Securitized products.

10.3. Additional information [OPTIONAL]

While most corporate issuers are assigned one of five tiers of ESG risk, a sixth tier exists for companies that are deemed ‘uninvestable’ from an ESG risk perspective.

An ‘uninvestable’ credit is one where we are unable to make a proper assessment of the company due to the ESG situations surrounding the company being highly uncertain. It is not to exclude companies we do not like from the investment universe, rather reflects where a proper assessment cannot be formed. The ‘uninvestable list is reviewed annually. Examples of currently excluded issuers include Adani Abbot Point Terminal and AMP.


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]

All else equal, a company with the same Internal Credit Rating (ICR) but a higher ESG risk assessment will be less attractive from a credit risk perspective and would require a higher spread premium to compensate for this assessment.

We take into account a company’s management of key material ESG risks and adjust our cash flow and gearing forecasts which impacts the ICR and valuations.


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

In Emerging Markets Debt we consider that the potential to deliver risk-adjusted returns is enhanced by the integration of ESG factors. ESG factors are an important part of bottom-up fundamental research and are included in all sovereign credit evaluations. Analysts review a common set of ESG data across all sovereigns, which enhances the objectivity and comparability of assessments. They also determine which ESG factors are market drivers for a given country, and produce a forward-looking assessment identifying where these factors are mispriced by the market. Engagement is used to support this assessment, where possible.

ESG considerations are also an integral part of portfolio construction, specifically as part of a position-sizing discipline. Here, limits to absolute and relative position sizes in portfolios are established by country, based on factors such as credit quality, volatility and liquidity, as well as a qualitative assessment of vulnerability to event risk.

Event risks refer to unexpected events with the potential to materially negatively affect bond prices – and it is our experience that such events are frequently linked to ESG factors. Examples include political succession, social revolutions and severe weather events. To assess the vulnerability of sovereigns to event risk, analysts consider the relative likelihood of them occurring (e.g. political event risks tend to be more frequent in countries where policy making is highly centralised), as well as the likelihood of drawdowns in response to the event. Using unexpected severe weather as an example, analysts assess potential downside by examining an economy’s diversification, looking at data such as the share of agriculture within GDP or the importance of agriculture to the balance of payments.

All else being equal, an assessment of higher drawdown vulnerability due to ESG event risks for any country leads to a stricter limit on the size of country portfolio exposure. We believe that this discipline has been a major factor in minimising drawdowns for client portfolios.

Corporate (financial)

ESG is an important component in the credit risk assessment process and determining the credit quality.

We have a 5-point ESG risk scale – Very Low, Low, Moderate, High and Very High. The ESG risk assessment is a key input into the  Internal Credit Rating (ICR). Analysts determine the number of notches penalty or uplift to the ICR based on the ESG risk assessment. Our process stipulates mandatory uplift or penalty to the weakest and strongest risk assessment.

We look at all pillars E,S, and G. Our focus in our analysis is the material ESG risks for the company and how management’s is responding to these risks.

Our internal ESG dashboard tool, along with ESG data providers helps us to pick up issues or problem areas in each pillar. Under each pillar we make an assessment of the severity of the risk and our assessment of the adequacy of management’s response.

Controversies – frequency and severity – as captured in news flow and Reprisk helps to indicate of how well companies are managing their ESG risks and where there is slippage between policy and implementation.

We also pay particular attention to governance structures (independence of the board, pay policies, audit committees), shareholder dissents, as well as incentives (ESG forming part of executive’s KPI’ and remuneration outcomes).

ESG developments are continually monitored and assessed. A full credit review, including ESG risk assessments are conducted when our view of the risks of the credit has changed. This is done at minimum annually.

Corporate (non-financial)

ESG is an important component in the credit risk assessment process and determining the credit quality.

We have a 5-point ESG risk scale – Very Low, Low, Moderate, High and Very High. The ESG risk assessment is a key input into the  Internal Credit Rating (ICR). Analysts determine the number of notches penalty or uplift to the ICR based on the ESG risk assessment. Our process stipulates mandatory uplift or penalty to the weakest and strongest risk assessment.

We look at all pillars E,S, and G. Our focus in our analysis is the material ESG risks for the company and how management’s is responding to these risks.

Our internal ESG dashboard tool, along with ESG data providers helps us to pick up issues or problem areas in each pillar. Under each pillar we make an assessment of the severity of the risk and our assessment of the adequacy of management’s response.

Controversies – frequency and severity – as captured in news flow and Reprisk helps to indicate of how well companies are managing their ESG risks and where there is slippage between policy and implementation.

We also pay particular attention to governance structures (independence of the board, pay policies, audit committees), shareholder dissents, as well as incentives (ESG forming part of executive’s KPI’ and remuneration outcomes).

ESG developments are continually monitored and assessed. A full credit review, including ESG risk assessments are conducted when our view of the risks of the credit has changed. This is done at minimum annually.

Securitised

The ESG integration process for Securitized products for Securitized product follows the same process as Corporate ESG analysis, however there are specific ESG issues for Securitized products that are detailed below:

Environmental – there is a risk of geographic concentration of assets to areas which could be affected by environmental issues, e.g. weather events. Pools of assets are assessed to ensure geographic concentration to regions and hence environmental events will not unduly affect the overall financial performance of the Securitized product

Social/Sustainability – origination and servicing processes of underlying pool assets is assessed to ensure that the processes are line with regulatory requirements as well as being undertaken on an ethical basis. This requires physical visits to the offices of the originator and servicer to ensure that the processes are in compliance and are appropriate.

Governance – Various models of ownership are evident across originators of securitized products. They can include listed, unlisted, private equity, individuals, trusts, and non-domiciled entities. Some of these models may provide additional risks for the investors in Securitized products. They can include less investment in technology and staff, higher dividend payments to owners, listed companies may be encouraged by equity owners to undertake activities which could be contrary to investors in Securitized product, and short term corporate strategies which maybe contrary to the investors of Securitized products.

12.3. Additional information.[OPTIONAL]


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