The lack of a standardised ESG scoring framework is making it difficult to assess the ESG impact of European CLO funds and the sustainability performance of asset managers, according to research by European ratings agency Scope Ratings.
European CLO funds are at the forefront of ESG standardisation as the largest asset class in securitisation products. The product is still in its early days, but stricter regulation is making it more important to measure the ESG impact of CLOs.
CLOs are not subject to the EU’s Sustainable Finance Disclosure Regulation, but many EU-based managers will have to provide ESG disclosure, whether or not their CLOs are marketed as such, which will allow greater transparency and comparison.
'ESG CLO' labels do not necessarily imply a stronger ESG performance, according to Scope’s research, and the range of measurements currently used to monitor CLOs’ ESG credentials, which include impact and risk, qualitative and quantitative analysis and relative or absolute scores, is leading to confusion.
"We’re seeing different scores per CLO asset manager. Some that label their CLOs as ESG score lower than others that don’t.” said Benjamin Bouchet, director of structured finance at Scope Ratings.
CLOs are the biggest buyers of leveraged loans and also invest in high-yield bonds. It is therefore possible to create an ESG score for CLOs by assigning ESG scores to each underlying borrower or issuer, and more second-party opinions are becoming available to help the process.
“The CLO is a strong product to push for more ESG standards because the underlyings are corporates and many have either second-party opinions or can be scored on an ESG scale. CLOs are also the biggest securitisation asset class in Europe. If it was to strengthen and capitalise on its ESG features, it would further increase its footprint.” Bouchet said.
Comparison possible
Scope has created ‘principle adverse impact scores’, which include companies’ supply chains and is independent of their reported information, which allows peer comparison across industries and regions. It does not assess how closely firms are following their ESG frameworks.
Scope looked at 420 European CLOs from 60 asset managers that closed between 2013 and early 2022, scored the borrowers that make up the collateral and checked the data quality of each CLO to give an absolute score.The final result covers 410 CLOs across 59 asset managers representing €166.15bn in assets.
While Scope has not disclosed its manager scores, it has identified the highest and lowest scoring sectors. Highest scoring sectors with the least impact are real estate (non development), professional services, telecoms and networking and banking and finance, and the lowest scoring sectors with the greatest impact are food, beverage and tobacco, agriculture and farming, wood and paper, energy and utilities.
"Companies with a low score are more likely to be involved in transition sectors. This analysis really shows you who is exposed to transition. It’s not an issue of who is good or bad," said Bernhard Bartels, executive director and co-head of Scope ESG Analysis.
Negative screening to exclude high-emitting sectors is the most commonly used ESG feature by CLOs, and was used by all the European CLOs that were refinanced in 2021. Only a handful of CLOs are currently using positive screening.
CLOs can improve their ESG scores by excluding higher-emitting sectors or increasing exposure to lower-emitting sectors. Issuer selection within sectors is another way to score well on ESG, and some managers are proving better at identifying ESG leaders in polluting industries.
There are other potential benefits for managers that are getting their selection right, particularly firms with multiple CLOs, such as Blackstone Credit (24) and Carlyle Group (21), Investcorp (19) and PGIM (19).
“We are starting to see better pricing terms for ESG CLOs compared to non-labelled ESG ones. If we continue to see greater price differentials, it’s positive for a further shift to ESG in the CLO market.” Bouchet said.