ESG INCORPORATION IN SECURITISED PRODUCTS: THE CHALLENGES AHEAD

What are the challenges related to the ESG incorporation in securitised products? PRI (Principles for Responsible Investment – the world’s leading advocate for sustainable investing, founded on a United Nations initiative) has recently published an interesting report on the incorporation of ESG in securitization products.

On one side regulators are increasing transparency requirements on sustainable related information on investment products. On the other, client demands and risk management are driving demands for considering the long-term impact and sustainability of investment choices. As a result of these forces, investors and asset managers are widening and improving ESG policies, but few of those are tailored for securitization products.

ESG information wanted by investors

Source: PRI

For ESG incorporation in securitized products to be effective, a holistic, multi-pronged approach needs to be developed. Compared to other asset classes the securitization market shows some additional complexity though including:

– Transaction structure: which implies a multi-level assessment of practices and policies including Sponsor and/or Issuer, Originator, Servicer, Deal structure, Loans, Collaterals or Guarantees. This is further complicated by the fact that parties can occupy multiple roles (e.g. servicer and originator) or involve private entities, which tend to be less transparent.

– Adequate data: Practitioners consider the ESG information in current deal documentation, marketing materials, and underlying portfolio disclosures insufficient to comprehensively analyze most securitized products.

– No ESG reporting standards for servicers/originators: Relevant ESG information on collateral often lacks uniformity and is not comprehensive.

– A diverse pool of underlying assets: the complexity and diversity of underlying collateral (and the sectors covered) make it difficult to build proprietary ESG frameworks that can be used for assessment.

– A lack of coverage by third-party ESG information providers: ESG information providers have limited coverage of securitized products. This is not surprising given that responsible investments originally developed in equities and only recently expanded to debt capital markets. Moreover, the leveraged finance market includes a high proportion of privately owned and smallcap companies that tend to disclose less information

– Lack of a clear ESG premium: differently from the so-called greenium that typically applies to green bonds, securitization transactions do not show meaningful price differentiation when incorporating ESG criteria[1]

As a result, of the 2,000 signatories that reported on their investment activities to the PRI in 2020, only 215 indicated how they incorporate ESG factors into their securitized product investments.

ESG incorporation in securitized products is at a very early stage

Source: PRI

To find a solution to the complexity above and sustain more ESG driven securitizations, PRIs have identified data quality, availability, and consistency as the main solution: a combination of robust in-house and third-party data sources is likely to drive investor confidence in ESG incorporation across securitized credit markets.

For further information please refer to the following link: https://www.unpri.org/fixed-income/esg-incorporation-in-securitised-products-the-challenges-ahead/7462.article

[1]Based on European ESG CLOs that were issued between March 2018 and August 2020 versus traditional CLOs