Asset owners and regulators are now expecting greater ESG transparency from securitized credit managers. Previously this has been limited by the lack of data availability and limited engagement with various stakeholders in the value chain, but we are now seeing progress in the right direction. Managers who remain inert will lag the wider peer group, potentially facing scrutiny from investors.
In ‘An asset owner’s guide to fixed-income ESG Integration’ we discussed the lack of ESG progress and transparency within securitized credit compared to other fixed income assets. We believe this is because of:
We have therefore seen managers typically focusing ESG efforts on areas within more traditional fixed income where the process is more straightforward.
There has been a push for change due to the increasing responsibility for asset owners to report on their portfolio’s ESG qualities and they are now expecting greater transparency from their securitized credit managers. We also believe, as with all asset classes, ESG is a financially material issue which can have significant implications on investment performance.
Further progress is needed for securitized credit to be on par with wider fixed income but, with a lot of engagement across the value chain, we are now seeing movement in the right direction. Differentiation between managers is becoming increasingly clear, with some leading the way forward and others being left behind.
WTW believe engagement with the asset management community is crucial to improving transparency and the standard of sustainable investing. Whilst progress in difficult-to-assess asset classes is slower than others, progress is happening.
Over the last few years we pushed securitized credit managers to integrate ESG into their due diligence processes and to establish frameworks for doing so. This is where we have seen most progress and many of our high-conviction managers now have proprietary frameworks for assessing the E, S and G factors of securitized credit assets within their portfolios. Now we expect managers to look beyond this.
We expect our managers to produce regular mandate-level engagement reporting for securitized mandates, as with other credit mandates. We have been engaging with managers regularly to ensure they continue to engage with various stakeholders to improve data availability, transparency and consistency. Key engagement targets are issuers, who choose the constituent loans of bonds, as well as industry bodies who have a large degree of influence on the policy and standards of the asset class.
We have seen leading managers engaging with originators as well as issuers. This can be managers sharing their proprietary estimations of carbon emissions for underlying assets with originators to improve data quality. We note originators tend to want to ‘correct’ estimations of carbon estimates that appear worse than expected. They are therefore motivated to work on providing the actual (or better estimated) carbon emissions.
Beyond climate-related engagement, we have seen progress in social-related engagement. This can be through implementing ESG based exclusions policies for loan pools or pushing for systems to deter predatory lending.
We have also seen examples of managers engagement with industry bodies including the Government-Sponsored Enterprise (‘GSE’), rating agencies and the Structured Finance Association (‘SFA’) on improving access to ESG related data.
Whilst some managers have robust processes, meaningful engagement with a measurable outcome is not yet standard for the peer group and reporting can still be a work in progress.
We believe all ESG factors are important, however many of our clients need to report climate emissions. As such, this has been a major focus of our engagement and we are pushing our securitized managers to record climate metrics and then report regularly on progress. This is a challenging area, not least for the reasons we detailed at the beginning of this paper, and we are seeing different levels of progress amongst our securitized managers.
Data availability varies greatly amongst the securitized credit sub-sectors. There are limited credible third-party data providers, affecting the ability of asset managers and owners alike to report on key metrics. This is one of the largest hurdles for improving transparency.
We have seen some managers report emissions at the issuer level, where data is more readily available. However, we believe this is a flawed approach which does not accurately capture the emissions of securitized portfolio as it does not account for the emissions of underlying assets.
There are some instances where managers can report on actual emissions at the underlying asset level. For example, this is possible with some CLOs where the CLO managers receive actual emissions data from loan issuers or with some Single Asset, Single Borrower (SASB) CMBS deals. That said, more commonly emissions are proxied. While not ideal, well-justified and consistent proxies still provide good indications of a portfolio’s trajectory and allow asset owners to report their estimated financed emissions intensity. Innovative managers can take a combination of publicly available data and survey responses to calculate emissions, but must do so with caution.
Industry emission averages quickly become outdated and data collection methods vary between geographies, making multi-national comparisons difficult. Yet we are seeing more managers commit to providing some level of reporting rather than avoiding it all together.
| CLOs | Auto ABS | Consumer ABS | RMBS | CMBS | |
|---|---|---|---|---|---|
| Underlying assets | Leveraged loans to corporates | Car loans and leases | Loans to consumers (i.e. credit cards) | Residential mortgages | Commercial mortgages |
| Data availability | Moderate Scope 1 and 2 emissions typically available from public corporates |
Moderate Third party providers increasing availability |
Poor No common approach yet. Social and Governance factors should be considered. |
Moderate/Poor Data sources such as EPC in the UK, or US Building Performance database in the U.S. |
|
| Ability to proxy emissions? | Yes, with industry averages |
Yes, by car make, model, age, etc |
Still a work in progress |
Yes, by property type and geography (region dependent) |
|
To maintain progress and improve transparency we recommend asset owners with securitized credit allocations:
We believe the above is key to maintaining momentum in improving ESG progress and transparency in securitized credit. Similarly, we think managers who adopt a wait-and-see approach for perfect data and industry frameworks before producing regular engagement and emission reporting will continue to lag the peer group. Engagement, reporting and a manager’s approach to broader-ESG are already important differentiators taken into consideration during our manager research process. Progress along the research process will remain dependent on a manager’s approach to all three factors, among others.
We will continue to work with securitized managers as they develop their capabilities.
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