Lecture 7 Flashcards
Government bonds & ESG
- Positive correlation between ESG scores and credit ratings
- Negative correlation between ESG scores and corruption
Corporate bonds & ESG
- ESG scores and corporate financial performance go together
- This translates more clearly into the risk of corporate bonds than into the return of equity
- Higher ESG scores are aligned with:
+ lower credit spreads, lower default frequency
+ higher credit ratings and fewer downgrades - High ESG scores imply that the firm is better managed, meaning lower risk
Type of SI and ESG result
SI 1.0 - Bond exclusion has a bigger effect to ESG results, than equities
SI 2.0 - Not clear or untested
SI 3.0 - Green bonds have positive ESG results. Private debt is very effective for ESG results
Mendiratta - Paper Corporate bonds
Problems
The data are not very convincing. It is based on ESG scores, which are opinions.
Mendiratta - Paper Corporate bonds
Findings for ESG performance effect on credit risk
- The three channels affect high and low credit risk companies.
- Better ESG rank is correlated with lower credit spread and better credit rating, imply low risk of default
- Firms with a high credit rating more through the cash flow channel.
- Firms with a low credit rating more through the idiosyncratic channel
Sustainability linked bonds
- Tie the bond issuer to a specific KPI (target regarding an ESG improvement)
- If he don’t respects it, a characteristic of contract changes (higher coupon)
Green/social bonds 4 components
These have 4 components:
1. Use of proceeds: Green or Social
- Process for project evaluation and selection: Ensure that project fit to the use of proceeds
- Management of proceeds: Track that money, go to a separated account destined for the project
- Reporting: Report the progression of both financial and impact results
Which is more popular: sustainability linked bonds or green bonds?
Green bonds are most popular. EU also issued such bonds.
Flammer - Paper: Corporate Green Bonds
Possible downsides of green bonds
- Limitation to a specific project
- Monitoring the project output and certification is costly
- Non-compliance with certification is a negative signal to investors
Flammer - Paper: Corporate Green Bonds
Conclusion
The findings are consistent with a signaling argument by issuing green bonds, companies credibly signal their commitment toward the environment
Mendiratta - Paper Corporate bonds
Transmission channels
Mechanisms by which the ESG performance of a firm translates to debt pricing.
- Improving cash flows
- Reducing exposure to systemic risk
- Reducing risk specific to the firm (idiosyncratic)
Bonds and “Voice”
- No voting: bondholders have no say at the AGM
- Engagement: bondholders can engage with firms just like shareholders
Impact bonds
- Sustainability linked bonds – proceeds flow’s in firm’s account, for any purpose, but under ESG conditions
- Green/Social bonds – particular use of money for a specific green/social project
Impact bonds
Certification
A consultancy analyze and approves that its green
These are important trust drivers
Impact bonds
Government benefits
Once a green bond is issued, the project is fixed and changes in power cannot stop it, because it will diminish trust in government and will anger investors which will start lawsuits
