IN BRIEF
Green, social and sustainability bond markets are growing rapidly, but remain largely unregulated. To ensure issuers meet sustainability requirements, it’s therefore vital that investors looking to gain access to these markets take an active, research-driven approach.
The JPMorgan Green Social Sustainable Bond strategy uses an investment process designed specifically to ensure that every bond selected for the strategy is aligned with the Sustainable Finance Disclosure Regulation (SFDR) definition of a “sustainable investment”.
We expand the investment universe to boost opportunities and reduce the impact of the “greenium”,1 take a forward-looking approach to exclusions of unsustainable bonds, and select sustainable issuers and securities based on the rigorous application of governance and use-of-proceeds criteria.
The result is a sustainable bond strategy with a sustainable investment objective (SFDR Article 9) that also allows investors to look at the portfolio alignment with the International Capital Market Association (ICMA) principles and alignment to the United Nations Sustainable Development Goals at the individual security level.
J.P. Morgan Asset Management’s Green, Social Sustainable Bond Strategy
J.P. Morgan Asset Management’s Green, Social Sustainable Bond strategy provides high-quality, core fixed income exposure to bonds where the proceeds are directed towards projects, and activities, that contribute to a more sustainable and inclusive economy.
Issuance of these “use-of-proceeds” bonds is rising fast, reaching USD 800 billion in 20222. Given the substantial investment that is needed to address the environmental and social challenges we face today, we’d expect the green, social and sustainability-linked bond markets to continue to grow rapidly, providing a compelling opportunity for investors to gain high quality sustainable fixed income exposure at attractive yields.
When it comes to investing in these markets, we believe an active, research-driven approach is vital. While international standards do exist to highlight best practice and encourage issuers to build robust issuance frameworks, these are nevertheless voluntary and largely unregulated, leaving passive investors more exposed to the ever-present risk of greenwashing that is often associated with labelled bond issuances.
Investing in sustainable bonds using an active research-driven approach
At J.P. Morgan Asset Management, our disciplined sustainable bond investment framework draws on the full resources of our global fixed income investment platform. Our research-based process expands the scope of the sustainable bond investment universe, applies a forward-looking exclusions policy, and actively selects sustainable securities from across global bond markets based on rigorous governance and use-of-proceeds criteria.
Sustainable investment framework
* Excluding cash and derivatives used for efficient portfolio management purposes. GSS = Green, Social & Sustainability. ICMA = International Capital Market Association.
1. Define the investible universe
The starting point in our active, research-driven investment process is the recently launched Bloomberg Global Aggregate Green, Social & Sustainability Index. This benchmark expands the investible universe beyond just green bonds, allowing us to also focus on the increasingly pressing social challenges faced by the global economy. However, we have decided to adjust the investible universe in two important ways:
First, we cap the broader benchmark’s duration at 10 years, since we believe that many of the projects requiring green, social and sustainable bond issuance are urgent. Issuing a longer-duration bond, with interim targets over a long-time horizon (such as 30 years) may reduce the imperative for an issuer to make tangible progress. Instead, we want to see a credible path for issuers to deploy capital quickly, with a relatively short timeline for reporting back to us on how their sustainability-related projects are progressing.
Second, we expand our investible universe beyond the benchmark, introducing the opportunity to invest in use-of-proceeds bonds from below-investment grade issuers. One of the reasons for taking this approach is that we want to be able to extend credit to those issuers who are actively contributing to the transition to a more sustainable economy, but who might not have an investment-grade credit rating. Also, we believe that being able to invest to a limited degree in high yield can provide another lever to generate excess returns over the benchmark, and ultimately help to mitigate the “greenium” that can be experienced when investing in green, social and sustainability bonds.
2. Take a firm and forward-looking approach to exclusions
Once we have established the investible universe, the next step is to apply a series of exclusions, which act as a minimum safeguard for the portfolio so that we will not finance issuers in violation of global norms, or those with significant revenue streams from the production of tobacco or weapons.
When it comes to environmental exclusions, we take a more nuanced, forward-looking approach. Companies deriving revenue from fossil fuels, or generating significant power from coal, oil and gas, or from nuclear sources, will usually be excluded. However, because we want to invest directly in the transition to a sustainable and inclusive economy, if an issuer in this category is actively in the process of shifting its business model towards renewables, or more environmentally sustainable practices – and is also issuing green bonds explicitly linked to this transition – we may actively invest in these issuances.
This exception is not a get out of jail free card. We want to see that the green issuance framework is directly integrated into the company’s core business model, and we will subject issuers to a stringent set of inclusion criteria before buying a bond. Furthermore, we will apply a heightened monitoring approach to such investments, ensuring that, as a firm, we are engaging appropriately and holding issuers to account on the deployment of the proceeds.
Case Study: Southern Company
- Southern Company is one of the largest utility companies in the United States. As of 2020, coal comprised 17% of its power generation mix, with 51% from natural gas, 17% from nuclear power and 15% from renewables. While this mix would usually result in the issuer being screened out from a sustainable portfolio, there are compelling reasons to actively invest in the company’s green bonds.
Southern has a credible transition plan, with a strategic intent to accelerate the phasing out of coal, and is targeting net-zero carbon emissions by 2050. It has already achieved a 52% reduction relative to a 2007 baseline. Despite the 2050 net-zero goal, the company believes that net-zero by 2035, in line with the Biden administration's goal, could be achievable with policy support.
The company has a robust green financing framework, with issuance geared towards investment in renewable energy: more specifically, the construction, maintenance and acquisition of solar and wind power infrastructure, as well as related research and development.
With at least 75% of issuance proceeds segregated for eligible projects, Southern operates a sustainable financing coordination group, comprised of members of different business units of Southern Company, which will evaluate potential projects and select them on an annual basis. The Treasury Department of Southern Company will approve such selections, and oversee the internal tracking of these projects. The company will also report back to investors annually on its progress.
3. Apply active inclusion criteria
Governance
Having filtered the investment universe via the strategy’s exclusion policy, we then apply a robust set of inclusion criteria to ensure that every single investment we make can genuinely be considered to be contributing to the strategy’s sustainable objective. We assess investments at both the issuer level and the individual bond – or issuance – level.
At the issuer level, it is paramount that the issuers to whom we extend credit exhibit good governance, regardless of the types of projects being financed by the bond. We look at governance slightly differently depending on the issuer type, noting that there are nuances across different fixed income issuers:
Corporate issuers: Our analysts complete a comprehensive 40-question environmental, social and governance (ESG) checklist as part of their overall research for each issuer. Within these questions, we have identified three key questions pertaining to governance: namely, whether an issuer has a history of poor governance, outstanding issues with labour relations, or questionable tax practices. Red flags identified for these questions may lead to an issuer being considered ineligible for inclusion in the strategy, regardless of the nature of the issuance, since we believe green, social and sustainable bonds should be held to higher standards than general purpose bonds. More information on our ESG research regards to corporate credit can be found in our fixed income ESG integration report >.
Sovereign issuers: In addition to the holistic ESG integration3 approach being adopted across our developed and emerging market government bond platforms, our green, social and sustainable bond universe only includes issuers that score in the top 80% of the World Bank Governance Indicator, which takes into account factors such as rule of law, control of corruption and political stability. More information on our approach to ESG integration and government bonds can be found in our sovereigns and ESG paper >.
Use of proceeds
Once we have established good governance, we then drill down on the use of proceeds for the individual issuance. We require that all green, social and sustainability bond issuances align fully with the principles set forth by the International Capital Market Association (ICMA). This well-established framework requires green, social and sustainability-linked bond issuers to be aligned along four key principles:
Use of proceeds: Proceeds will be directed to appropriate projects
Project evaluation and selection: Issuers have a credible process for selecting projects
Management of proceeds: Proceeds must be appropriately segregated and managed
Reporting: The issuer will report back on the progress post-issuance
To ensure alignment with the ICMA principles, we have developed a proprietary questionnaire, completed by each research analyst, and accessible within our research database, Spectrum. Analysts are required to complete this questionnaire for each green, social and sustainability-linked bond that they cover, and they must therefore explicitly verify the alignment with the ICMA principles as a condition for investment.
Analyst questionnaire guides sustainability verification for every issuance
Case Studies: Verifying the sustainability of a bond issuance
The result: Full transparency and alignment with sustainable activities
The result of our robust issuer and issuance-level assessment is that every bond that is eligible for our green, social and sustainability strategy qualifies as a sustainable investment, as defined by European Union Sustainable Finance Disclosure Regulation (EU SFDR).
We can also break the portfolio down by theme, to understand how much of the portfolio is aligned to one or more sustainable activities as defined by the ICMA . And because the ICMA has aligned its categories with the United Nations Sustainable Development Goals (UN SDGs), we can also get a view of portfolio alignment to the UN SDGs at the individual bond level.
Alignment with the ICMA Green, Social and Sustainability Bond Principles
% of portfolio aligned with ICMA sustainable activities
Source: J.P. Morgan Asset Management. Data as at 31 December 2022. In order to be considered an eligible green/social/sustainable bond, our analysts must determine that at least 75% of the use of proceeds will be directed to at least one of the 16 sustainable activities defined by the International Capital Markets Association (ICMA). The above data is a representation of how much of the fund, by market value, partially or fully aligns with each category based on our analysis of each bond’s offering documents. A bond’s alignment with an ICMA category is not a guarantee that all proceeds will be directed to that activity. Issuers will be expected to report the actual use of proceeds at least annually post-issuance. Total will exceed 100%, since use of proceeds bonds may specify more than one sustainable activity in their offering documents. **Circular Economy Adapted Products, Production Technologies, and Processes.
Alignment with the UN SDGs
% of portfolio aligned with UN SDGs
Source: J.P. Morgan Asset Management. Data as at 31 December 2022. In order to be considered an eligible green/social/sustainable bond, our analysts must determine that at least 75% of the use of proceeds will be directed to at least one of the 16 sustainable activities defined by the International Capital Markets Association (ICMA). Each category is mapped by ICMA to the sustainable development goals, and the above data is a representation of how much of the fund, by market value, partially or fully aligns with each SDG based on its alignment with the ICMA project categories. A bond’s alignment with an ICMA category or SDG is not a guarantee that all proceeds will be directed to that activity or theme. Issuers will be expected to report the actual use of proceeds at least annually post-issuance. Total will exceed 100%, since use of proceeds bonds may specify more than one sustainable activity in their offering documents, and be mapped to multiple SDGs.
As an active investor, the work does not stop here. Given that reporting is one of the key principles of the ICMA framework, we expect issuers to keep us informed of the progress of the projects they have pledged to fund, and to be transparent around the deployment of investor capital. We continually monitor these issuer-level allocation reports, and as an EU SFDR Article 9 strategy, the fund is committed to reporting back on the progress of these investments on an annual basis.
1 The greenium refers to the slightly lower financing costs that green, social and sustainability bonds can provide to issuers compared to traditional bonds (and hence lower yields), mainly driven by strong demand for these types of securities.
2 Source: HSBC Research. As at 31 Jan 2023
3 The systematic integration of ESG factors, along with other factors, into our actively managed fixed income portfolios helps us identify and act upon financially material risks and opportunities, with a nuanced approach for each sector team. ESG integration does not, however, change a strategy’s investment objective, exclude specific types of companies or constrain a strategy’s investable universe.
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