Posted inESG

Hermes finds correlation between ESG and credit spreads

Though traditionally it has been more difficult to price in ESG risks accurately for bonds than for equities, the fund house has devised a new model based on charting an issuer’s ESG score with the spreads on their credit default swaps.  

Hermes applied its own quantitative ESG score to the companies included in the study, which builds on research by data provider Sustainalytics, as well as data from MSCI and other third parties and findings from Hermes’ own in-house team.  

Looking at the CDS spreads of 365 companies between 2012 and 2016, the Hermes team found that companies with higher ESG scores tended to have lower credit default swap spreads, even when corrected for credit ratings.

Companies with a ESG score of one out of a possible five, with five representing issuers that scored the highest on ESG concerns, had an average annual credit default spread of around 250 bps.

Whereas issuers that earned a score of five had CDS spreads just above 100 bps on average.  

 Source: Hermes

Across the main sub-categories of environmental, social and governance, the team found that there was a similar correlation between a high score in one area and lower CDS spreads.

“Although credit risk is the principal driver of both the level of and changes in credit spreads, we know that ESG factors also influence credit spreads,” said Hermes credit co-head Mitch Reznick. 

Though the relationship between credit spreads and ESG scores looks very strong, some of it can be explained by other factors. For example, companies with low ESG scores are often also relatively highly leveraged.

Article continues on the next page

Kristen McGachey

Kristen joined Last Word Media and the world of financial journalism in April 2016, leaving behind a career in a legal publishing firm as a senior researcher turned assistant editor. This native Angelino...

Part of the Bonhill Group.