Assessing the ESG characteristics of mortgage and other asset-backed securities (ABS) are an "essential component" of investing in securitised markets, according to Morgan Stanley Investment Management (MSIM).
However, ESG integration has been "largely neglected" in the ABS market because of the complex legal structures of securitised arrangements, which require multiple levels of due diligence by the investor to assess the sustainability characteristics of the underlying loans or assets, combined with the current lack of sufficient and granular ESG data for these underlying investments, said Navindu Katugampola, global head of sustainability, global fixed income team at MSIM.
"The challenge, or the opportunity of securitisation, really lies in thinking about the availability/transparency and granularity of the underlying loan data," Katugampola said.
"Oftentimes, when we look at disclosure on the corporate side, there is high degree of transparency that's available. That's been deficient on the underlying loan data in securitisation."
To that end, Morgan Stanley Investment Management have developed a proprietary sustainability framework for securities portfolios, leveraging the specialist knowledge of analysts and investment team.
The framework combines in-depth analysis of the specific environmental, social and governance characteristics of each deal, scoring of the deal on a 1-5 scale, based on its overall ESG profile, and mapping of the positively- and negatively-scored deals to the applicable United Nations Sustainable Development Goals (SDGs), for consistent tracking and reporting of a portfolio's overall sustainability alignment.
"The threshold for us saying a deal is making a positive contribution is quite high."
"We've seen this in some transactions, where a bank is making a general statement that lending to residential is helping people getting on the housing ladder.
"That's not compelling enough. You're doing business as usual - lending to help people buy houses, that's your job. That's not trying to make a difference. That's classified as neutral, even if the originator says it's positive. We judge positive by lenders saying how are you helping people on low income, those who live in disadvantaged areas, etc. That's going beyond business as usual."
Issuance does not have to be based on underlying labelled green/sustainable/social assets to have defined impact or positive characteristics.
"We map issuance towards an SDG framework, which is different to a labelled green/sustainable bond format."
"We are talking about the distinction of the labelled green market, and what securitisation offers in terms of looking at the underlying loans and what you might achieve through that lending activity."
Morgan Stanley Investment Management also engages with issuers in securitisation markets based on the belief that pre-issuance conversation can have impact.
"There is a growing realisation that you can be quite influential as a fixed income investor when it comes to engagement,"
"Ok, fine, we don't have voting power. But we can vote with our money because the majority of transactions that happen on the equity side are on the secondary market, whereas in the fixed income market, it's primary. That gives us regular opportunities to deal with issuers and to tell them yes, we're investing because we like these aspects of what you're doing."