Approach to responsible investment

We believe in the science of climate change and that a transition to a low carbon economy is underway. Issuers’ responses in tackling climate change will likely have a substantial impact on their credit profiles, and in turn, their probability of default. Both physical risks (financial risk rising from extreme weather patterns, natural disasters, supply chain disruptions, employee safety and disruptions to operations) and transition risks (financial risk rising from changing strategies, policies or market behaviours as society and industry transitions to a low carbon economy) are likely to be disruptive for issuers, where cost of physical risks could outweigh the benefits in the short term for most issuers. Nonetheless, costs related to transition risk would also escalate over time as the highly fossil fuel powered Asian region navigates decarbonisation.

Limited action against climate change will intensify the frequency and severity of extreme weather conditions, impacting issuers’ assets, supply chains and employee safety. In particular, property and casualty insurers would be the most vulnerable as they face higher insurance underwriting risks, while utility issuers would also be at risk with higher natural hazards posing significant risks to their access to natural resources, as well as supply chain and logistics.

Transition risk is also meaningful to our Asian credit strategies as the region continues to ramp up efforts towards regulating climate-related risks. Industrial and utility issuers will be challenged with business and regulatory risks as they endeavor to achieve an orderly transition from coal to more costly natural gas and renewables, while financial issuers are likely to face higher carbon prices and regulatory costs over the long term. Sovereign and government-related issuers, especially those operating in more energy-intensive and fossil-fuel-dependent economies, are more likely to be impacted in their transition to a lower carbon economy.

As the window to decarbonise and limit global warming is closing fast, we expect the impact of climate-related risks on the Asian credit market to be dynamic and related regulation to evolve rapidly. Hence, it is critical for us to continue to assess and monitor the resiliency and ability of issuers to adapt to climate change and stricter climate policies. Issuers who do not make the transition in an orderly manner will be at risk of being left behind with higher reputational, regulatory and business risks, with their assets potentially devalued or written-off before the end of their expected economic life.

Climate-related risks are identified and assessed by credit analysts, who are sector specialists with wide-ranging experience and a deep understanding of respective markets and sectors, supported by a dedicated Responsible Investment team. We assess the impact from the relevant sector or issuers’ operations and products on the environment, including but not limited to issues of waste/emission management, resource use, energy intensity and sustainability.

Climate-related risks are assessed as part of our detailed Environmental Social and Governance (ESG) Risk assessment. Our credit analysts rely on a combination of company engagement, sustainability reports and third party ESG research and data providers to arrive at their ESG risk assessment.

Credit analysts also assess the net zero alignment of individual issuers, utilising the framework developed by the IIGCC (The Institutional Investors Group on Climate Change). The framework allows a detailed analysis of issuers’ commitment towards decarbonisation including short- and long-term carbon emissions targets based on a Science-Based approach (in line with meeting the 1.5 degree goal of the Paris Agreement), as well as specific energy and revenue mix, and capital expenditure for its pathway towards net zero. Furthermore, we also conduct scenario analysis on individual issuers’ implied temperature rise based on committed forward-looking decarbonisation targets, as well as the actual recent carbon emission performance.

Moreover, our access to third party carbon data allows an analysis of carbon intensity at both individual issuer and the portfolio level, which enables a quick comparison of carbon intensity between different sectors, portfolios and benchmarks. 

Our views on issuers’ climate-related risks are incorporated into a separate ESG risk rating, which is one of key rating drivers for the independent Internal Credit Rating (ICR). With the ICR being a core aspect of portfolio construction, our assessment of climate-related risks naturally flows through the entire portfolio construction and credit selection processes.

In addition to issuers’ individual ESG risk rating, analysts are also required to indicate whether ESG Risk is on an ‘improving’, ‘steady’ or ‘deteriorating’ trajectory. An issuer that is not demonstrating improvement or showing limited willingness to commit or align itself towards decarbonisation goals would be assigned a higher ESG risk rating or a negative ESG risk trajectory, which could result in a lower Internal Credit Rating (ICR). A five point scale, ranging from ‘very low’ to ‘very high’ ESG risk, is utilised for the ESG risk rating, and this rating gets incorporated into an issuers’ overall Internal Credit Rating (ICR) and reviewed at least annually. This dynamic credit process enables us to form an independent view from the external ratings, and seek an adequate risk premium for higher climate-related risks.

Issuers with poor ESG risk ratings could end up being excluded from our portfolios. Where analysts are unable to form an adequate assessment of the company due to the high uncertainty and lack of transparency of their ESG assessment, the company is deemed ‘uninvestable’. This ‘uninvestable’ list of issuers is reviewed annually and portfolio managers are notified as and when there are changes to the list.

Furthermore, our Stranded Asset Framework also allows us to identify issuers with high risk of asset stranding due to global action on climate change, changing economics, new government regulations, evolving social norms and the impact of new technologies. A traffic light system is used to highlight issuers with higher risk of its assets being stranded before the end of their expected economic life, especially when they have very long-dated bonds outstanding.

Key climate-related risk performance indicators such as greenhouse gas scope 1 and 2 emissions (emissions from direct operations and from the use of electricity, respectively), or disclosures on coal usage as they are increasingly made available by issuers, are periodically monitored. We also track overall portfolios’ progress including the net zero alignment as well as the carbon intensity.

Against a fledgling Asian investment landscape that is starting to embark on addressing climate-related risks, our credit analysts also monitor issuers within the investment universe for climate awareness and initiatives. This process is undertaken as part of the overall effort to identify all material ESG risks faced by an issuer, where credit analysts monitor individual issuers’ pathway to net zero as well as Scope 1 and 2 emissions.

Key challenges remain with Asian issuers’ relatively weak disclosure standards and a lack of standard taxonomy. For example, government and agency issuers, often have insufficient disclosures on climate change initiatives, although since 2020 many have started to propose mandatory or voluntary disclosure standards. Developments in China are of particular interest due to its prominence in Asian Fixed Income Indices, and the recent voluntary disclosure standards recommended by the China Enterprise Reform and Development Society (CERD) (in 2022) has been encouraging for progress. Through engagements with issuers over time, the team believes that the climate change awareness within the investment universe will continue to grow and mature, and this will in turn help us manage climate risks better. 

As we progress with incorporating climate change awareness and standards in the Asian region, we have top-down portfolio level targets for our Asian Credit strategies, excluding sovereign, quasi-sovereigns and agency bonds. Our quantitative targets are based on thresholds of the portfolios aligned to net zero. These targets focus on the proportion of the portfolios that are committed, aligning or aligned to net zero by 2050. The criteria for defining each status is based on the framework developed by the Paris Alignment Investment Initiative Net Zero Investment Framework Implementation Guide.

We aim to outperform benchmark in ESG metrics, and one way to achieve this is by gradually reducing exposure to investments in high-emitting assets and increasing exposure to low carbon assets. With the ultimate aim to achieve net zero in our Asian Credit Strategies by 2050, our targets take a phased approach, reflecting the challenges resulting from a lack of disclosure and limited net zero targets set by Asian issuers.

Based on the current state of climate governance and disclosure standards as well as accountability in Asia, if the existing standards and lack of disclosures remain as-is for the years to come, there will remain a significant number of issuers, such as sovereign and quasi-sovereigns, for which we will be unable to conduct an in-depth quantitative ESG assessment from a climate assessment perspective. For such names, we will continue to rely predominantly on a top-down qualitative assessment of the issuer from the closest perspective we can achieve (e.g.: at the sovereign or agency level). As fixed income investors, we cannot vote, but we will strive to influence issuers through dialogue during the course of due diligences, roadshows and through other channels that are available to investors. With time, the goal is to have our Asian Credit Strategies achieve consistently better emissions disclosure with net zero alignment plans compared to their respective benchmarks and overall investment universe.