Does This CDO Come in Green? With ESG Everywhere, Buyers BewareAdvisor Perspectives
It started with bonds. Now even collateralized debt obligations (CDOs) come in green. From the humble bank loan to a complex swap, there is virtually no corner of finance for which an ESG product hasn’t been created. Experts say investors should tread cautiously.
In less than a decade, ESG—a style of lending and investing that gives the same weight to environmental, social, and governance issues as to traditional metrics such as leverage and cash flows—has moved out of the wings and onto center stage. Wall Street has unleashed engineers and experts on structuring and marketing securities to offer a whole load of new financial products.
HSBC Holdings and JPMorgan Chase have priced ESG cross-currency swaps, Goldman Sachs is experimenting with so-called green equities, and Deutsche Bank has created several green repurchase agreements. Barclays has offered green structured products to retail investors, Axa priced an ESG collateralized loan obligation, and Standard Chartered crafted an ESG capital-relief trade. There are green mortgage-backed securities and ESG labels on asset-backed commercial paper, synthetic CDOs, credit default swaps, and money market funds. Some bonds are even being labeled “blue” to show they support water-related causes such as ocean preservation or sustainable fishing.
The phenomenon has all the hallmarks of a Wall Street mania. But in this case the new products are supposed to go beyond enriching investors—and actually change the world for the better. Over the next three decades it will cost about $100 trillion to meet net-zero emissions goals, not to mention the funds needed to address other environmental and social problems. Can green finance make a real difference, or is it just misleading marketing hype, otherwise known as greenwashing?
“ESG products, so long as the banks and fund managers selling them have comprehensive plans to lower the emissions of their portfolios in line with science, could be the final puzzle piece that helps shift the trillions necessary for the transition,” says Casey Harrell, senior strategist with environmental nonprofit the Sunrise Project. “Without such a plan, greenwashing is the inevitable outcome.”
The acid test is whether an ESG product meaningfully raises the cost of capital for polluters compared with more environmentally friendly entities, says Ulf Erlandsson, a former Barclays Plc credit derivatives analyst who now runs the Anthropocene Fixed Income Institute, a climate-finance think tank. “The plethora of ESG pitches with pictures of children dancing around wind turbines at sunset but without any fundamental analysis is highly indicative of ESG being oversold,” he says.
The ESG market today, with its lack of standardization, is “caveat emptor,” adds Eila Kreivi, chief sustainable finance adviser at the European Investment Bank in Luxembourg. Kreivi, who’s been involved in structuring and setting criteria for green bonds for more than a decade, says to “be careful what you buy and make sure your first question is always ‘Explain what you mean by ESG.”