Navigating the market requires increased expertise as it matures
By Tom Gresham
Climate change has introduced a range of new risks and opportunities for financial institutions and investors. Alexandria Fisher, manager, sustainable finance, for the Global Risk Institute in Financial Services, said the fixed income market faces many of the same challenges as other asset classes when navigating sustainable finance markets, such as the availability of robust and comparable data, but she said fixed income also faces its own unique complexities. In particular, fixed income has faced explosive growth in Canada in the speed, scale and range of sustainable finance products that are available.
Alexandria Fisher
“In other classes, you don’t have the same diversity, which makes the level of expertise needed for sustainable finance in fixed income often comparatively higher,” said Fisher, who delivered a keynote address on the topic, “Climate Change and Sustainable Investing: An Inflection Point for Fixed Income,” at the CAiP Fixed Income Investments in Pensions Forum in early June.
Fisher said a major part of the push toward sustainability comes from investors who are leaning on companies to make net zero decarbonization commitments.
“ESG used to be a more niche thing, but it’s gone mainstream,” Fisher said. “Customers and beneficiaries are asking more questions about this and demanding their asset managers take action on it.”
Unlike other financial risks, Fisher said, climate risk is not cyclical in nature. That means that it’s here to stay.
“It’s going to keep increasing unless there is some drastic massive change,” Fisher said.
That makes it more difficult to model, Fisher said. However, the widespread recognition of climate risk’s potential impact on financial system stability has made it an increasingly popular topic for close study. Fisher said the importance of expertise is accentuated in Canada because of the prevalence in fixed income products of greenwashing, which is the practice of making a product seem more environmentally beneficial than it actually is.
“One of the things that’s happening is there is a kind of incredible demand, and the demand is far outstripping the availability,” Fisher said. “When you’re accelerating this quickly, it makes regulation difficult.”
Greenwashing can have ramifications far beyond those involved. Fisher said the negative perception of one issuer can impact “the trust of everyone in the market.”
“Even if your product is great, if there are other people who are greenwashing in the market, it can have reputational risk for the entire industry,” Fisher said. “And once trust in the products has declined, it’s quite difficult to reestablish it.”
Fisher said greenwashing is not always done with “a lot of intentionality.” Instead, it often is a reflection of the relative lack of understanding of the ESG (environmental, social, and governance) market. She said greenwashing can be mitigated with the right tools in place, particularly by working with experts who have literacy in sustainability and climate-related risks and how they may impact investments.
“In the climate space, metrics and comparable data are not as robust, and there tends to be a fair degree of ambiguity,” Fisher said. “That means managers have to rely more on judgment and expertise than your solid traditional audited numbers and financial analysis. It’s important to have people who are subject matter experts but also to have education on this topic more broadly throughout the organization.”
Fisher said a lack of comfort with climate/ESG data can lead to “analysis paralysis” that keeps some from embracing sustainable finance products.
“Climate risks can vary significantly, depending on how the product is structured, as well as the maturity of an individual bond, so there needs to be a more robust understanding of how specific product attributes are impacted by climate risk,” Fisher said.
From an issuer perspective, Fisher said that firms that are ESG laggards – and that are not assessing climate or ESG risks in their decision-making processes – could see a decline in their access to capital.
“That could result in the inability to refinance existing debt or issue new debt,” Fisher said.
Fisher said the fixed income space tends to be the “least developed” when considering ESG or climate risk integration. “I think that speaks to the difficulty of the space, but also speaks to the fact that more companies and more investors are trying to actually figure this out,” Fisher said.
Fisher said a particularly promising area of growth is transition finance, which includes products that help high-carbon companies start to implement long-term changes to become greener. These products bridge the gap between traditional and sustainable financing for businesses beginning the move toward net zero carbonization.
“These green products can help significantly fill the gap,” Fisher said.
Looking ahead, Fisher believes the sustainable finance market in fixed income will continue to mature and become more standardized.
“We’re going to see that through voluntary [efforts], government regulations and investor scrutiny there is going to continue to be increasing transparency, robustness and credibility of sustainability commitments and disclosures from companies,” Fisher said.
Tom Gresham is a freelance writer with more than 20 years of experience in journalism.
