The Stock Exchange of Hong Kong Limited (the Exchange), published the Environmental, Social and Governance Reporting Guide (ESG Reporting Guide) in 2013, and it has been a recommended practice since then. Subject to consultation, Hong Kong Exchanges and Clearing Limited (HKEx) plans to raise the level of obligation of some recommended disclosures to “comply or explain” in 2015. Many listed companies started their ESG reporting journey years ago, and some published their very first report recently in response to the ESG Reporting Guide. However, there are still a number of companies that have decided to wait until ESG information disclosure becomes compulsory before taking action. The findings of a new report from Principles for Responsible Investment (PRI), Corporate Bonds: Spotlight on ESG Risks, provide a good reason for companies to start going beyond compliance: that is, that investors believe ESG performance impacts a corporate creditworthiness.
The report starts by highlighting the fact that institutional investors are increasingly taking ESG factors into consideration when they make their investment decisions, and more importantly, this is a result of increasing demands from their clients to include ESG considerations as part of the analysis of corporate crediworthiness.
“Creditworthiness is a function of a company’s profitability, productivity, competitive position, as well as estimated future value and cost of capital, ” the report says.
The findings are drawn together from two approaches: a literature review and an analysis of case studies and feedback from practitioners, including some of the largest global fixed income managers, asset owners and service providers. The literature review shows evidence that there is a correlation between ESG performance and a company’s credit quality. Studies reveal that strong performance in environmental management, employee relations and governance is linked to better credit quality, and also affects a range of other aspects including bond prices, bond ratings and cost of debt. For example, companies that have poor environmental risk management practices are charged 20 percent higher interest rates compared to those with better environmental performance. On the other hand, practitioners feel the link between ESG performance and creditworthiness is less direct. The materiality of ESG factors tends to vary from sector, region, timescale, and are often specific to the company. However, evidence from case studies, supports that adding ESG factors into the investment assessment profile could help to identify the potential financial losses at the early stage.
Though this report only focuses on the links between ESG factors and companies fixed income investments, there are hundreds of other studies conclude that ESG performance impacts the corporate financial creditworthiness in one way or another. For example, Deloitte’s Review Finding the Value in Environmental, Social, and Governance Performance examines investor behavior and confirms ESG issues can have an essential impact on a company’s financial well-being, as well as management and culture. A paper from Sustainable Investment Research Platform, The Added Value of ESG/SRI on Company and Portfolio Levels, also reveals that ESG factors have a direct impact on both a company’s financial performance and risk profile in the long run.