The output of this detailed analysis is usually a comprehensive report, Gallagher continued. “For companies that make it through the negative screen, the next step is to carry out fundamental credit analysis including seeking out topical or ESG risks that are not priced in compared with other names within the same sector.”

The final stage applies to labelled bonds only. Here, Artesian carries out comprehensive use-of-proceeds (UOP) analysis at security-by-security level. Gallagher said it is entirely possible for a company to pass Artesian’s ESG and credit screening but then to be knocked out of investment consideration at the UOP stage.

Pendal embodies the ESG integration approach. George Bishay, portfolio manager at Pendal in Sydney, explained that the fund manager merges ESG analysis within its credit processes. It does so by examining material ESG risks associated with an entity or a sector to determine whether these risks are managed well enough.

“Ultimately, the concept of material risks being managed well enough or not is a decision in its own right and can be separated from other fundamental analysis decisions,” Bishay added.

In a further indication of the growing integration of ESG analysis in the Australian fixed-income market, the survey shows a marginal increase in the importance of ESG factors other than negative screening in the investment process. Close to 80 per cent of 2021 respondents say ESG has a significant or somewhat of a role in investment decisions, up by 6 per cent year-on-year (see chart 5). Other than negative screening, however, ESG analysis typically provides guidance to the investment process rather than a direct pricing signal or an outright red or green light (see chart 6).

Investors at the roundtable described the outcome of this enhanced analysis process as in many cases requiring increased issuer engagement as an additive ESG approach.

For equity investors, the ability to use active ownership to advocate for good corporate governance and to improve the long-term value of a company has been a mainstream investment concept for some time. Despite not having shareholder voting rights, debt investors say they are increasingly using engagement techniques.

“A big change for us in the last 12 months is the engagement we have had with issuers,” Pauline Chrystal, portfolio manager at Kapstream Capital in Sydney, said. “Where an issuer is at now is not the highest priority but rather its progress made and its willingness to embrace change, increase disclosure and engage with investors to tackle risk.” Investors suggest corporate engagement is an alternative to screening out issuers whose activities might otherwise simply exclude them from portfolios.

Pendal’s dedicated strategies have a hard exclusionary screen and the fund manager will not invest in ESG laggards. Bishay added: “It is not the end of the story even when we identify material risks. Where we can, we will continue an engagement process with the issuer in the hope it begins to manage these risks and we can eventually include it in our investible universe.”

Anoticeable change in sentiment in the 2021 survey is investors’ expectations and requirements in relation to issuer reporting – specifically the level of detail fund managers want.

Whether at issuer level or transaction specific, a plurality of survey respondents want to see more detailed issuer reporting. This marks a change from the 2020 survey, when the largest single group of investors was satisfied with “basic impact reporting” (see chart 7).

Gallagher believes these demands are a reflection of the increasing sophistication and detail of the reporting investors themselves are providing. He explained: “We are constantly canvassing companies to improve their reporting, whether in line with TCFD [Task Force on Climate-related Financial Disclosures], PCAF [Partnership for Carbon Accounting Financials] or other requirements. We ask companies to improve their reporting so we can improve our own reporting back to our investors.”

In a sustainable-finance market in which reporting and measurability are becoming increasingly important to a range of participants, investors are seeking information from a wide range of sources to support their ESG analysis. The picture here is largely unchanged from 2020: more than half the investors surveyed use all of issuers’ sustainability reporting and normal disclosures, their own in-house capabilities, rating agencies, and certification and verification providers to inform their ESG analysis (see chart 8).

Asset managers note the broad range of options available and suggest access to multiple sources of information is important. For example, Ardea Investment Management’s Sydney-based principal, Tamar Hamlyn, explained that ESG investment in the government fixed-income sector is a very different game from the credit space (see box).

One of the biggest issues on which the Commonwealth bank of Australia (CBA)-KangaNews survey seeks to shed light is whether investors or issuers should bear the brunt of the upfront cost of improving ESG outcomes. Relative to survey outcomes 12 months ago, investors appear to be giving up some ground.

In the 2020 iteration of the survey, more than 60 per cent of respondents said they were not willing to offer any degree of preferential pricing for GSS bonds. A clear change in the investor view can be seen in the 2021 survey data, as only a third of respondents say they would not be prepared to pay any premium for a UOP GSS bond (see chart 9). At the same time, investors say desire for improved ESG outcomes but lack of willingness to pay for them is less of a barrier to growth in 2021 than it was in 2020 (see chart 10).

Ward argued at the roundtable discussion: “I think some investors used to believe they physically had to go into their pockets and cost-share up front – not really appreciating that if they are buying a labelled bond through an issuer’s vanilla curve, this is effectively how they were paying for it. Investors that were new to ESG investing thought a good way to get runs on the board was to buy some green bonds and build up a portfolio. As the market has evolved, I think investors are more comfortable that they can do good and still perform well.”

This evolution of investor mindset can be seen clearly through market dynamics – specifically the ongoing and significant supply-demand imbalance. Anthony Kritikides, executive director and head of institutional sales at CBA in Melbourne, added: “Recent GSS deals have been at least 2-3 times oversubscribed and the situation is not helped by the fact investors have tended to buy and hold – so it is proving difficult to find stock in the secondary market.”

According to some, the market may have moved on entirely from a pricing debate on GSS bonds. Bláthnaid Byrne, director, sustainable finance at CBA in Sydney, said at the post-survey roundtable discussion: “The impact on pricing in GSS issuance is largely minimal. It is more of a communication tool. The value is in the demonstration of an issuer’s commitments to its ESG strategy.”

Survey data support this view, as investors suggest the remaining timeframe issuers have to access capital without paying a material premium for poor ESG performance is shortening (see chart 11). Some 94 per cent of respondents believe time will run out within five years and 100 per cent predict it will be within the next decade.

Survey data also demonstrate the extent to which the buy side is willing to share the cost of market evolution. More than half of investors say they would be prepared to buy a bond or loan product with a two-way margin adjustment provided ambitious targets are met, while the corresponding cohort in 2020 was just 33 per cent.

Mandate evolution is also at play, as no investors say they are unable to participate in sustainability-linked instruments for mandate reasons in 2021, compared with a quarter in 2020 (see chart 12).

Investors are noticeably more willing to explore options for transition finance in 2021. For example, 84 per cent of survey respondents say they are either “very keen” or “open to” supporting brown-to-green transition instruments in 2021 (see chart 13).

In an almost complete reversal of the survey outcomes from 12 months earlier, transition-based products feature highly on the list of investors’ most preferred ESG approaches for further development, while they seem less confident in the future growth of labelled GSS product.

In 2021, the proportion of investors interested in development of transition instruments has almost doubled, while those keen to see further growth in GSS bonds has fallen by around a third (see chart 14).

Supply may be having an impact on UOP issuance. “What is holding the market back is the lack of underlying projects for UOP bonds – there are simply not enough wind farms or solar parks to back UOP bonds domestically,” Bishay argued. “I think we will see significant growth in the SLB [sustainability-linked bond] market because the proceeds fund general corporate activities and do not require ringfencing of specific, predetermined projects. This is easier for most companies.”

Before the SLB market in Australia can thrive, however, investors suggest that greater clarity on some aspects is needed. They are willing to lend a hand in this development.