ESG Impact Ratings
Introduction to PGIM Fixed Income's ESG Impact Ratings
- Concept: ESG Impact Ratings reflect PGIM Fixed Income’s assessment of what is a positive and negative impact for the planet and good for society. ESG Impact Ratings are not credit ratings; they are not an assessment of a company’s ability to repay debt, which is already integrated in our internal fundamental credit ratings.
- ESG Impact Ratings: Assess how debt issuers impact the environment and society, regardless of whether we feel those impacts are immediately credit material.
- ESG Impact Categories: Five, clearly defined categories setting our ESG expectations for issuers.
- Scale: The scale spans from 100 to zero in increments of five, with zero as the lowest and 100 as the highest ESG rating.
ESG Impact Categories and Definitions
Corporate ESG Impact Ratings Methodology
- Assessed each industry for environmental and social impacts
- Identified what we felt to be key negative impacts and positive differentiators
- Key negative impacts and positive differentiators are specific for each GICS industry group, industry, and sub-industry and reflect our view on the most important negative and positive impacts of issuers within each grouping
- Developed guidance for ESG Impact Ratings ranges and medians at GICS sub-industry level (including further breakdowns as appropriate)
- Developed Guidance on the application of governance factors to ESG Impact Ratings
ESG Impact Categories and Examples of GICS Industries
ESG In Credit Research
ESG is incorporated into our credit research processes. Through issuer analysis, we are able to identify credit material ESG factors for each industry, as well as the negative and positive impacts that this industry can have on the environment and society. With this information in mind, we can better engage with issuers, developing a constructive dialogue where our assessment and analysis is provided to the issuer, pertinent issues are raised, and the economic and reputational implications are discussed.
*It is important to note that unlike equity investors, fixed income investors have a contractual relationship with a company. Whereas equity holders, as owners, have more direct influence over management.
Securitized Products ESG Impact Ratings Methodology
- Coordinated ESG Impact Ratings evaluation with Corporate Credit Research based on the asset class, issuer, and nature of collateral
- Identified key negative impacts and positive differentiators
- Focused on utility and appropriateness of the financial products backing securitizations from the perspectives of the borrowers, lenders, and investors
- Developed guidance for ESG Impact Ratings ranges and medians by asset class subsectors
- Developed guidance on the application of governance factors to ESG Impact Ratings, including:
- Competency of third-party service providers, particularly loan originators and servicers, and potential impact to borrowers, lenders, and investors from regulatory, legislative, and judicial interventions
- Key governance constructs in securitization documents and how structural features and amendment rights are designed to protect investors, particularly in the event of collateral underperformance
- Use engagement with issuers, third-party servicers, industry advocacy group, fellow investors, and other market participants in order to improve outcomes for investors and borrowers
ESG Impact Categories and Examples of Securitized Assets
ESG In Securitized Products
Within securitized products, consideration of social and governance ESG factors is core to PGIM’s evaluation of all consumer lenders, especially in the unsecured subprime consumer lending subsector. In our issuer engagements we focus on how the loan product design affords good utility for the borrower, the lender and the securitisation investor. In assessing responsible lending, we conduct due diligence on the lender’s consideration of a borrower’s ability to pay relative to their income, other debts and living expenses, and the lender’s servicing practices.
Green, Social, and Sustainable Bonds
Our Approach
A case-by-case analysis of the credibility and additionality of individual green bonds is part of our security selection process. Credibility is assessed at the security and issuer level, while additionality measures the potential incremental positive impact that the bond could have on the environment.
The combination of the credibility and additionality assessments determines the assessment of the overall impact of the bond.
Credibility
In order to assess impact, we need to understand an issuer’s overall ESG strategy and how the green bond fits into that strategy. A green bond is more credible the more that it is consistent with, or supportive of, an issuer’s ESG strategy.
Under our framework, we consider whether an issuer is following the green bond principles. These assess whether the issuer established overarching ESG policies and objectives, created an implementation strategy, and, where appropriate, implemented specific targets that the proceeds from the issuance will directly support.
Furthermore, it is preferred that the bond’s proceeds only finance eligible projects and that issuers provide complete transparency regarding the specific use of proceeds. Timing also plays a role in establishing the credibility of a green bond—the faster the proceeds are distributed to a green project, the better.
Additionality
Our framework assigns a higher ESG Impact Rating to green bonds with a greater environmental impact. The more the green bond enables a transformation from brown activities to green ones—either in terms of the issuer or the industry—the greater its incremental impact. For example, if the proceeds have been slated for an existing project or would have happened regardless of the bond, then the issue has less of an impact. All else equal, we assign higher additionality to bonds where proceeds are being used to finance new projects versus refinancing existing ones. When proceeds are used in part for refinancing, the longer the lookback period (or, the timeframe in which existing projects might be financed with proceeds from a green bond), the lower the additionality.
The additionality assessment under our framework favors disclosure of the anticipated impact of the bond using quantifiable impact metrics, ideally that are normalized to millions invested. We also prefer regular impact reporting following a green bond offering.
*Versus issuer-level ESG impact rating.
ESG Impact Ratings Uplift*
The overall impact assessment allows us to decide whether a given bond’s ESG Impact Rating deserves an uplift compared to the issuer’s ESG Impact Rating and, if so, to what extent. For example, the numeric uplift from a green bond could be additive to an issuer’s numeric ESG Impact Rating.
- A use-of-proceeds ESG labelled bond can have an ESG Impact Ratings uplift vs. its issuer, from 0 to 40 points
- Any ratings uplift is a function of the issuers and bond’s credibility, and the potential incremental positive impact of the issuance
- Bond ratings are subject to periodic reviews after issuance and may be revised in light of actual activity
Source: PGIM Fixed Income. Note: An Issue may have a different ESG Impact Rating from an Issuer in the case of ESG labeled bond issuance. ESG labeled bonds are assessed under PGIM Fixed Income’s Green, Social and Sustainable Bond frameworks. For illustrative purposes only. Subject to change. Not indicative of future expectations. In the case of both credit material ESG factors and negative & positive impacts, the lists shown are illustrative. Actual topics considered will vary depending on the issuer and its circumstances and may not include all of the topics listed here and/or may include other topics not shown.
