ESG is challenging for the structured finance industry
How does S&P Global Ratings see the implementation of ESG metrics and risk exposure analysis within today’s securitisation industry?
Matthew: There is a very big industry effort underway to come up with principles-based disclosure standards across different structured finance asset classes. Originators are seeking to understand what data they have available and what data should they be collecting. The corporate universe is working a lot on ESG disclosure frameworks.
However, considering the exposures in structured finance transactions, there seems very little work so far on quantifying asset-specific exposures using key performance indicators or other metrics which we could track for structured finance asset classes. Right now, the industry is trying to work out how it can leverage what has been done in the corporate space regarding ESG and adapt it to make it appropriate for structured finance vehicles.
ESG-related finance transactions
Beth: I think we are still at this early stage. Many of the ESG-related structured finance transactions up until now have been largely confined to the collateralized loan obligation (CLO) space and limited to negative screens which is similar to how ESG began in the past for other sectors. This means tackling the low-hanging fruit by, for example, excluding tobacco companies. What we hope to see going forward, is to add a little more maturity to the ESG landscape relating to structured finance. Data is perhaps the biggest challenge at this stage.
Are you seeing improvements in data quality at this time?
Matthew: Under EU securitisation regulation there are disclosure fields in loan level templates for the Energy Performance Certificates (EPC) of residential properties or auto loans, however, this data is not mandatory. Nevertheless, a lot of the buy-side participants are asking for that type of data regardless of legislation.
Beth: These data, even if they are available and accurate, are collected at point of origination. As an investor, if you are looking to show improvement in the ESG performance of what you are investing in, you do need some form of tracking mechanism over the lifetime of that transaction. And that is something I don’t think has ever really existed in securitisation. So that would certainly be a new type of data request.
It is clearly difficult to find ESG information in loan origination and see what that information does over time. How is S&P Global Ratings looking at these new types of data requests?
Matthew: One of the biggest goals for us right now is to connect the loan-level data that we get in securitisations to ESG data fields. We’ve done some research on physical risk data (heatwaves, cold waves, water stress, sea level rises, river flooding) and we have been able to tie that back to the exposure in specific CMBS and RMBS transactions. We are now also looking at collecting EPCs for properties over time. To date we still haven’t seen enough information in the historical performance of property with a high EPC versus a low EPC ratings in order to have an opinion on the differences in credit quality.
As we are now are seeing a pressure on energy prices, we are curious to test the hypothesis whether lower energy costs result in more disposable income available to service debt. Regarding auto loans, we have been differentiating between diesel vehicles verses more efficient Euro 6 rated petrol vehicles for some time in our analysis. This recognises for example that a lot of cities now are imposing additional duties or taxes to drive in city centres, or indeed prohibiting some of the older diesel models in large city centres.
Beth: When we perform ESG evaluations or evaluations of the sustainable debt markets, we are looking at the stakeholder-based definition of materiality. Materiality is the principle of defining the social and environmental topics that matter most to your business and your stakeholders. This means that you supplement your investment decision-making based on not only the credit risk, but you also add considerations such as ESG factors.
More recently in structured finance, we have been providing second-party opinions which relate to labelled debt. So, if the debt is green labelled, social labelled, or sustainability labelled (which is a mix of green and social) we then provide an opinion on whether or not the frameworks of the originators are aligned with the International Capital Markets Association (ICMA) Green Bond Principle, for example. That gives investors more confidence in what they are investing in.
For more information or tickets, visit the eventpage of the Securitisation Event 2022.
Are S&P Global Ratings developing specific tools for embedding ESG into securitisation analysis or is it still too early.
Beth: It’s interesting because the ICMA principles were not written for the securitisation market but for the market in broad terms. We know there is some work being undertaken at the moment to provide additional guidance about how you might apply these to the securitisation market. So, we have been publishing some of our views on this. But there are still a lot of challenges and open questions which the whole market has to work through.
Matthew: ESG considerations in credit ratings aren’t new. We have historically always been considering these: what is changing is the taxonomy and nomenclature around it, and an increasing demand for transparency. We have released industry report cards identifying for each sector what some of the common ESG factors which would fall under the E, S and G categories across the asset classes. And we will also soon publish ESG credit indicators in a quantitative alpha-numeric format which express our view of the influence of environmental, social and governance risks on each of the five main aspects of our analysis in structured finance transactions.
Accusations of greenwashing and social washing are often lurking around the corner: how can the securitisation industry avoid the pitfalls of false representation?
Beth: The challenge for us all is to clearly define what constitutes green and social investments. When it comes to securitisation the main question is: ‘at what level is the ESG assessment done, and is that the appropriate level?’ There are many different layers which you could include in an ESG assessment. Ensuring that process is transparent, is probably one of the most important factors. Alongside simply having a common definition of what’s is green and what is social adapted for this segment of finance.
Matthew: In terms of labelled deals, we are seeing a lot of framework alignment opinions. I think that works well when you’re thinking of unsecured corporate issuance. However, a structured finance transaction with specific collateral is rather different.
Once you dig down to the level of detail of a loan-level data tape you might ask yourself additional questions on the framework in order to analyse whether or not a specific transaction would also meet the principles.
What are the principle differences in terms of ESG data between issuers and investors?
Matthew: I think it depends whether you are talking about the credit impact or sustainability impact because that’s going to naturally drive what data is relevant. When originators are underwriting and servicing loans their primary consideration is likely ‘am I going to get repaid for advancing this money?’ And while repayment is important, from an investor’s point of view they also might have a mandate for some kind of impact or sustainability objective.
Is there an increasing demand in the marketplace for some clarification on ESG and sustainability in general?
Beth: There are certainly a number of industry-led initiatives right now to come up with some standards. These include the UNPRI which has a structured products working group, the structured finance association has an ESG working group as well to try and develop reporting standards, we’ve had ICMA has been working to come up with some further clarifications for securitisations, so as a whole the industry is really trying to determine what are the relevant fields that we want to see, and it will be a mix of both from a credit quality perspective as well as from an impact perspective, but I think the starting point is for everyone to at least be speaking a common language.
What could the future look like as the securitisation industry evolves more ESG standardisation?
Matthew: One of the reasons we haven’t seen a lot of issuance of green or social labelled deals in structured finance today (even if there is sufficient ESG data) is that it is very challenging to actually get sufficient scale of green assets. We have heard recently that there have been private deals done where the cost of funding in the securitisation is dependent on ESG targets that are being set for the originator instead, so we could see that work its way into public markets. And I think that does at least address the fact that you don’t necessarily need specific collateral that’s green or social, in order to do a sustainability -linked transaction.
What are your main reasons for attending the Securitisation Event in Amsterdam?
Matthew: I’m really looking forward to hearing the feedback from investors and issuers about what they want to see from S&P Global Ratings in the ESG space I’d like to know if the so-called “greenium” exists in structured finance: meaning is that more advantageous cost of funding for a more sustainable issuer, or the counter argument: is an investor willing to accept less yield in order to purchase a green or social-labelled bond? Also, I’m very interested to hear the state of the market and to hear how important ESG considerations now becoming in their mandates.
Beth: I’ve very curious to find out if there has been any real progress in terms of people’s thinking regarding ESG, as we haven’t physically met for a while now. It will be great to get together with everyone in the industry and hear from way more people than you would do in a virtual conference setting. Getting a finger on the pulse of everything that is going on will be very interesting to find out what people’s views on this subject are today will be very worthwhile.
For more information or tickets, visit the eventpage of the Securitisation Event 2022.
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