A question for credit risk in Asia is just how much longer the issue of environmental, social and corporate governance (ESG) can be ignored as an input, whether it’s in relation to fixed income, or at the broader level of bank balance sheet safety.
The Paris climate change agreement, or COP21, signed last December but still to be ratified by the required international quorum that would see it pass into international law, looms large for any investor seeking to map the credit risk landscape of the next few years and far beyond.
With the COP22 about to be convened in Marrakech in early November, the fact that the US and China have each ratified the COP21 Treaty, which seeks to reduce greenhouse gas emissions to zero by the second half of this century as well as to limit global warming to 1.5 degrees Celsius between 2030-2050 adds greater urgency and perhaps a sense of a fait accompli to the discussions in Morocco.
This, of course is all about the “E” element of the ESG programme – for want of a better word – but the other two elements of the acronym are not striding far behind. And having lagged behind for years on that entire programme, Asia is finally beginning to wake up to its urgency from a multi-dimensional perspective.
China, the world’s biggest emitter of greenhouse gases, has not only drawn a line in the sand for the rest of Asia with its ratification of COP21, but it has gone one step further; it now requires all corporations to report on ESG as a mandatory element in all financial reporting. France is the only other country to have made such reporting mandatory.
These rapid strides in the ESG stakes, come as China emerges as the world’s most fertile source of Green bonds. It would be easy to describe China’s almost evangelical zeal when it comes to the “greening” of its economy as an exercise in smoke and mirrors. After all, the country still allows debt issuance from coal producers to be labelled as Green, something that sticks in the craw of the dyed-in-the-wool global ESG community.
But that is probably to split hairs. What China has grasped is that increasingly, the credit risk assessment framework, from its most formal publicly accepted expression – credit ratings – to the granular work done by credit committees at the banks and at institutional investors, must include ESG input.
Under the aegis of the United Nations-supported Principles for Responsible Investment, China’s Dagong Ratings is now formally including ESG considerations in its ratings methodology. As indeed are Moody’s and S&P. The clock is now ticking for those investors who have chosen to put off the ESG consideration until a rainy day.
Some of the credit risk elements embedded in ESG are relatively straightforward to ascertain. So for example, if the COP21 accord is ratified into international law, large swathes of the fossil fuel industry will become redundant. Mining companies and attendant ancillary service companies will become unviable, simply because regulation will create “stranded assets.” The same will be the case for oil companies as the regulations take hold.
In the meantime you would have to worry about the loan books of banks with high exposure to the fossil fuel industry. We are having a first taste of that as Asian oil field service companies struggle to service debt and embark on debt restructuring.
That is all about the cashflow problems associated with low oil prices. In the coming years it will be about confronting the non-viability of companies with assets that have been obliterated by a wave of COP21-conforming regulation.
Jonathan Rogers is a contributing editor at The Asset.
