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
Flammer - Paper: Corporate Green Bonds
Motivation to issue green bonds
- Signals commitment towards the environment?
o Can we test for greenwashing? - Are green bonds a cheaper source of funding?
Flammer - Paper: Corporate Green Bonds
Test if green bonds create a positive signal
Event study with effect of issuing bonds on stock return
- Investors respond positively to the issuance announcement of green bonds (stronger for first time
issuers, certified bonds and natural resource heavy companies) - The issuers experience an increase in ownership by long term and green investors (groups overlap)
Flammer - Paper: Corporate Green Bonds
Test company behavior
The issuers improve their environmental performance post issuance
Flammer - Paper: Corporate Green Bonds
Test cost of capital
There was no significant results regarding a green bond premium, so there is no cheaper funding
Mendiratta - Paper Corporate bonds
Transmission channels
Improving cash flows
Strong ESG > More competitive > Higher profit > Easier to pay interest > Lower credit risk
Mendiratta - Paper Corporate bonds
Transmission channels
Reducing exposure to systemic risk
Strong ESG > Lower systemic risk > Lower cost of capital > Higher valuation (bond & equity)
Mendiratta - Paper Corporate bonds
Transmission channels
Reducing risk specific to the firm (idiosyncratic)
Strong ESG > Better risk management > Rare incidents > Lower default risk
