The BIS paper, ‘Green bonds and carbon emissions: exploring the case for a rating system at the firm level’ assesses the impact of fighting the climate crisis through green-bond-funded corporate projects, concluding that “green bond projects have not necessarily translated into comparatively low or falling carbon emissions at the firm level.”1
The authors suggest that a firm-level, green-rating system based on carbon-emission intensity would incentivise companies to align their decarbonisation with the goals of the Paris Agreement.
Decarbonising the economy is security agnostic
We unequivocally agree that climate assessments at the security level are not a good way to assess the decarbonisation pathways of individual firms. And while green-bond-financed projects are necessary in solving the climate crisis, they are not sufficient.
The growth of the green-bond market (see figure 1) is clearly a positive development, yet decarbonisation will not happen unless companies find ways to create economic value and simultaneously align their activities with the goals of the Paris Agreement. As such, we believe the BIS authors are correct to shift the focus away from projects and towards cumulative corporate actions to tackle the climate crisis.
Figure 1. Sustainability-themed credit issuance
Source: Bloomberg New Energy Finance, as at October 2020.
Scoring carbon intensity: a possible input, but not a panacea
The firm-level, green-rating system separates the distribution of companies into deciles based on carbon intensity. But if this is employed, it should form only one aspect of the investment process and not be relied on as a self-contained measure.
Because the score is based on historical data, it needs to be placed in the context of a more complete ex-ante assessment. For example, a company that is currently managing climate-related physical and transition risks through mergers and acquisitions, capital expenditure or technology could still score poorly using this metric. Yet if we see value in a firm’s debt securities, it is these companies – the ones making demonstrable changes – that we wish to invest in and engage with.
And while a standardised scoring system would bring benefits, calculating emissions intensity for comparative purposes is more easily done than in the past. Environmental disclosures have improved rapidly, while the number of data providers has also grown. In addition, the Carbon Disclosure Project scores – which scores companies on environmental performance – provides insights that are comparable to that of the proposed scores.
A shift in focus
We are encouraged by the principal message of the BIS paper and agree that there is a need to incentivise firms to decarbonise their economic activities if we are to achieve the goals of the Paris Agreement.
At the international business of Federated Hermes, we take a holistic view of corporate environmental, social and governance (ESG) behaviours and use stewardship to inform our view of how companies are bringing about positive change. As such, we firmly support the idea that the focus should shift from green-financed projects to broader change at the firm level.