These observations have helped fuel a backlash against ESG in recent months, with banking industry insiders like HSBC’s Stuart Kirk, investors such as Vivek Ramaswamy, and outspoken CEOs like Elon Musk decrying the movement’s perceived contradictions and broken promises.

But despite all this noise, credit market professionals still see multiple ways in which ESG can make a tangible difference in companies’ fundraising efforts and investors’ portfolios.

For one thing, high yield companies that express a dedication to sustainability — whether by issuing an ESG-labeled bond or simply by providing additional ESG disclosures or targets — often receive greater demand from buysiders when raising debt.

That includes orders from new ESG-focused funds that wouldn’t be involved otherwise, or from big money managers like BlackRock and PGIM that will increase the size of their regular orders to satisfy extra demand from their ESG funds.

“Instead of putting in a $50m ticket like they would for a non-ESG bond, maybe it'll be a $60m ticket or $75m, in some instances, you'll see investors double their demand,” said a banker who led a high yield ESG deal earlier this year.

“If a deal is struggling or is in a tough spot in a really hard market, could that make the difference? Yes, it could.”

But whether investors are limited to ESG-labeled deals or have a broader remit, many of them prefer companies that are proactive when it comes to ESG, sources told 9fin. Why? Because it shows that the management team is looking out for the company’s best interests.

“We'd love to say that we buy them because we think they'll outperform, but the reality is we're not sure that particular ESG security is gonna outperform,” said Peter Schwab, a high yield portfolio manager at the ESG-focused investment firm Impax Asset Management.

“We're hoping that a company will actually outperform because it's better, because it’s a bit more forward-thinking, and in theory, over time, they're going to be moving a little bit faster than their competitors in these areas, which should accrue to their competitive position.”

Supply and demand

A popular way for companies to express their commitment to ESG principles is by issuing so-called “labeled” bonds.

These include green notes, where proceeds are intended to be used specifically for projects that reduce emissions: for example, a capex project to reduce excess water usage at a factory, or to install solar panels on a company’s warehouses.

There are also social bonds, where proceeds are intended to be used to increase equality. OneMain Financial issued a social bond last year that used proceeds toward making personal loans to “credit insecure” borrowers, 75% of which are racial minorities and/or women.

There are also sustainability-linked bonds (SLBs) where proceeds can be used for anything but interest costs may vary based on whether or not the issuer meets certain ESG targets. Packaging company Novolex used this structure back in April, raising $4.61bn via two bonds and a loan.

Novolex’s notes lay out a plan to reduce greenhouse gas emissions; if those goals aren’t met, the coupon rate rises by 12.5bps in 2025 (one common criticism of sustainability-linked debt is that such goals are not ambitious enough, as 9fin’s ESG analysts explain here).

But while there has been a handful of ESG-labeled deals this year from issuers such as Ardagh Metal Packaging, telecommunications firm VodafoneZiggo and iron ore producer Fortescue Metals Group, it has not been enough to satisfy the growing appetite.

Despite a 75% plunge in overall HY issuance year-over-year, issuance of ESG-labeled high yield bonds in the US market has remained more or less flat over the same period, according to data from Bank of America.

Four ESG-labeled bonds were priced in the second quarter, totaling $3bn — roughly on pace with the $2.6bn that priced in the first quarter. For comparison, some $4.3bn of labeled bonds were issued in 4Q21, and $2.1bn priced in 3Q21.

With overall high yield issuance volumes down so drastically this year to date, labeled ESG bonds now account for 7.76% of total HY issuance in 2022, up from 4.1% over the trailing 12-month period, according to BofA.

But that’s simply not enough to satisfy the growing demand from ESG funds — and this is true even as investors pull away from the broader high yield market.

“It's been hard, frustratingly hard,” said Schwab at Impax. “There's just not enough supply at all. Anytime there is a deal, it does seem to get a huge amount of attention regardless of the profile.”

Fund flows back this up. From January to April there was a $2.9bn inflow into US ESG bond funds (across IG and HY) compared with an $80bn outflow from non-ESG bond funds over the same period, according to a BofA report published in June.

When it comes to ESG, the US investment grade market has seen a lot more labeled issuance (Apple is a regular in this field) than high yield. But there are signs that high yield investors are paying closer attention.

According to a recent BofA survey, US high yield investors are more likely (17%) to say they adhere to strong ESG guidelines in their investment decisions than high-grade investors (5%), according to a survey conducted by BofA.

The data is mixed, though: some 30% of US high yield investors said they have little to no incorporation of ESG, compared with less than 20% in investment grade. For some observers, that simply reflects the greater focus on credit risk that HY investing demands.

“At this point, especially at this critical moment, the sensitivity to credit risk right now will totally overwhelm the ESG credentials of the company,” Schwab said.

Look elsewhere

There is still plenty of skepticism around labeled ESG issuance, whether it’s around the use of green or social bond proceeds, or the way goals are set for sustainability-linked debt.

The recent backlash against ESG has added fuel to that fire. But overall, investors are gradually becoming more sensitive to ESG, said Daniel DeYoung, a high yield portfolio manager at Columbia Threadneedle.

“You can see it everywhere you look, everybody's got ESG funds and green funds,” he said. “Issuers are actually starting to respond to the demand with more supply and increased disclosures, even for our non-public bond issuers.”

This reflects the fact that there are not enough labeled ESG deals to go around, which is leading many of funds to widen their nets for eligible investments.

One approach is to look at companies that are yet to issue green or sustainability-linked debt, but have laid out sustainability goals in annual reports or other such disclosures.

“There just simply isn't enough of the specific labeled bonds to create any real portfolio,” Schwab said. “So you're stuck with the whole universe of high-yields bonds to parse through.”

Impax uses internal modeling and its own ESG scoring system to determine which credits qualify for the fund, he said. Other funds use internal systems, but many rely heavily on third-party scores from MSCI and Sustainalytics to screen out credits with the worst ESG scores.

Some of the largest such funds include BlackRock’s Global High Yield ESG and Credit Screened Fund (with $221m of net assets) and PGIM’s Global High Yield ESG Bond Fund (with $10m in ESG investments).

The results of this approach underline how uncorrelated ESG has become with industries that many observers would typically associate with environmental sustainability.

For example, PGIM’s Global High Yield is invested in some labeled notes, such as the green bonds that Eco Material Technologies priced back in February.

But it has a much larger exposure to bonds issued by Chesapeake Energy. That company has no ESG-labeled bonds in its capital stack, but last year it launched a website detailing its goal to achieve net zero greenhouse gas emissions by 2035.

Likewise, one of the biggest holdings in Blackrock’s fund is the senior unsecured notes that Bellring Brands issued back in March.

Proceeds of the notes were used to fund Bellring’s spinoff from Post Holdings, rather than any specific sustainability projects; but the company has ESG goals and discloses its progress on reaching them in an annual impact report.

“It doesn't necessarily have to be a green bond,” said the banker who worked on the ESG deal. “Having the actual official ESG tag makes the job of the investor easier, but some of these funds will invest in non-ESG labeled deals because they still view them as environmentally friendly.”

These funds may not avoid more pollutive sectors (such as energy, metals and utilities) altogether, but they are likely to have lower exposure.

Additionally, they often look for the companies within those sectors with the most robust ESG disclosures, and those that are best positioned to survive emerging trends like the transition to green energy.

Ultimately, that might have little to do with what is good for the environment, but it may have everything to do with what is good for the company. And that goes to the core of what ESG has come to mean: identifying risks, and quantifying their financial impact.

“ESG is not about how businesses change the environment,” said a portfolio manager. “It is about how the environment impacts the business.”

“Sustainable investing is about investing in things that will benefit and not harm the environment and society long term, whereas ESG has basically become a list of broader trends that companies have to figure out how to navigate.”