Research urges investor caution in ESG
Investors who want their money benefitting environmental or socially impactful causes have a fairly straightforward path with corporate bonds.
Issuing companies can specify exact goals such as carbon-reduction or boardroom diversity in prospectuses and disclosures - and will be graded as such through green-bond ratings or third-party scoring assessments.
But thematic investing becomes more complicated in the asset-backed arena. Instead of a single management entity, a fixed-income portfolio might represent dozens or hundreds of assets with varying degrees of compliance and risks with environmental, social or governance (ESG) factors.
ESG impact and risk can also range widely in securitizations, depending on the type of asset classes being pooled.
“Subprime auto loans have little in common with [commercial real estate] transition loans,” Deutsche Bank noted in a February markets research report. And “[e]ven within an asset class, each securitization has differences in structure, collateral and sponsor.”
Deutsche’s report laments the lack of ESG standards for asset-backed securities, in what it terms the “early days” of ABS sustainable investing.
Opacity just doesn’t affect investors; issuers are challenged as well in following and substantiating ESG criteria in their pools. They are limited by ill-defined standards of what ESG means and the fact ESG might potentially be at odds with credit-risk or other investment criteria.
For example, a solar-panel ABS transaction might satisfy an investor’s choice to support sustainable energy, but it may also trigger governance risks in asset or geographic concentration, or long-term contract affordability for borrowers.
ESG criteria “must extend across the securitization,” Deutsche’s report stated. “Solar financing may get high points for ‘E,’ but structures must reflect the risks.”
A lack of regulations and standards have also introduced confusion in ferreting out “greenwashing,” or unsubstantiated claims by companies their products or businesses meet sustainability efforts, according to a paper from BlackRock on sustainable investing in securitizations.
A focus on “clear, objective data” can help asset owners better understand the sustainable standards of their investors, as well as help “describe their approaches and measure performance,” according to a January white paper by BlackRock. Unfortunately, “a true set of global rules or standards are unlikely to emerge in the near term.”
The lack of standards doesn’t just cloud potential risks, but also fails to showcase some advantages that securitizations can have for ESG-focused investors.
In January private banking firm Brown Brothers Harriman in New York released a study showing how securitized assets can shield investors from ESG risks – particularly in social and governance factors – in comparison to holders of corporate bonds or equities.
In one example, BBH noted that stock and bond prices fell for General Motors following the 2014 recall of nearly 30 million vehicles worldwide due to faulty ignition switches (ultimately linked to 124 deaths). “We found that the securitizations, the asset-backed securities, didn’t decline at all in price,” said Neil Hohmann, a managing director and head of structured products at BBH. “Investors in asset-backed securities know that they don't have a direct guarantee of repayment from GM. Instead, they know that they're isolated legally from GM by the separate legal structure.”
BBH’s newly launched securitization evaluation framework shows lower ESG risk factors for ABS bonds across 30 asset classes, since asset-backed securities held within bankruptcy-remote trusts are insulated from corporate event risks.
“For us, that was really strong evidence of the protective effect from ESG incidents that securitizations provide,” said Hohmann.