I spoke late last week to a rather charming fellow in Hong Kong who has just joined index provider MSCI as vice president of ESG research.
Informed readers of this column will be familiar with MSCI, formerly Morgan Stanley Capital International, which compiles a vast array of indexes which are tracked as standard operating procedure by most of the world’s institutional fund managers.
Of late I have written rather a lot about the topic of ESG, in relation to the shifting global landscape of environment and social and corporate governance. A key takeaway from my conversation with MSCI’s Mervyn Tang – previously an analyst at the Bank of England – was his confident assertion that ESG is now absolutely, without ambiguity, fear or favour, a mainstream item on investors’ radars.
But actually, the reason for the phone call was my curiosity as to how ESG factors assert themselves in relation to the fixed income product, rather than in equities.
A chance meeting at a recent environmental conference in Berlin led to this call and the erudite Mr Tang led me through the thinking from MSCI’s point of view.
It wasn’t necessary that his previous employment as an analyst at Fitch Ratings made me assign particular credence to his comments about ratings methodology in its traditional incarnation, but it was an anchor of sorts within the conversation.
The history of the evolution of ESG from the investor perspective provided a useful contextualisation: the whole project basically started as the result of shareholder activism, and the hope of leveraging ownership – often at the minority shareholder level – in order to change outcomes based on ESG considerations.
And in the 1990s, wherein ESG thinking has its origins, the approach was basically qualitative rather than quantitative. Which means to say that the credit call was largely made via subjective judgement rather than on the basis of data collection. Quantitative objective measurement didn’t quite exist.
But the reality seems to be one of getting the category right. The problem with integrating ESG thinking into the fixed income product versus equities, as a distinct investment category, is one of product diversification. So with the debt product there is an array of different offerings across maturities and with a variety of levels across the capital structure.
And there is your duality between equity and debt from an ESG point of view. So to take banking in the case of the former asset class, higher levels of regulation might yield lower returns from an equity investor’s point of view but a reduced risk of default through a fixed income investor’s pair of eyes.
The reality is that the higher the regulatory stringency, the lower the credit risk from an investor’s point of view versus the payoff in potential equity gains.
Meanwhile the voice from MSCI also explained the granular nature of the ratings project when it comes to ESG considerations. So the scores which emerge from MSCI tend to be based on data rather than qualitative analysis, although a fascinating aspect of my call with Mr Tang was to know that the company has a team assigned to assessing “controversies”.
That term should be self-explanatory but he further explained to me that MSCI aims to put such headline risk in a steady relation to the data revealed about that company’s financials.
The recent controversy surrounding the Weinstein Corporation for example, to pick a random example, should be seen fully in the context of data points within the company’s capital structure. In other words, MSCI aims to be rather more robotic and less intuitive in making credit calls versus its competitors.
As far as the ESG suite of contemplation is concerned, MSCI runs Green bond indexes with Bloomberg Barclays for which MSCI is responsible for verifying whether bonds in the index are ‘green’.
In all this, Mr Tang explained to me that ESG ratings criteria apply in a diverse manner across asset classes. So whereas the application of ESG to equity might well be straightforward, the application to fixed income is rather more complex. One might well find oneself confronting a divergence between the ESG rating of a holding company and the subsidiary from which it issues bonds.
A fascinating final point from this conversation was the prospect of the study Mr Tang is undergoing at MSCI to determine the relationship between ESG factors and the pricing of credit default swaps. The sweep of this undertaking includes Asia so I will be fascinated to learn when the results of the project are released just how governance in Malaysia, the Philippines and Thailand – I pick these three countries for their obvious top-down governance challenges – have impacted on the price of credit protection.
It seems like a pipe dream, but maybe such ESG methodology and its proven impact on a country’s cost of credit might indeed impact, top-down as it were, on government policy. It’s a noble ambition and I suspect MSCI might be well positioned to start that ball rolling via data rather than judgement calls.
