S&P Global Inc. (SPGI) Earnings Call Transcript & Summary

Hello, everyone. And welcome to this very special webinar from LCD, Root and Branch, a look at ESG's emergence in the global leveraged finance market. My name is Nina Flitman. I'm a senior editor at LCD News in London. Thank you very much for joining us today, wherever you are, and we hope you're well. And we're very happy to have with us today some thought leaders from S&P Global, from LCD, and from the capital markets world to detail ESG's growing presence in the European and U.S. high-yield bond markets and leveraged loan world, specifically looking at how green and sustainability-linked deals have been structured today, how this segment has performed so far, and what challenges and opportunities it might present to investors down the road. Now before we begin, as ever, a couple of housekeeping items, and we do want today's webinar to be interactive. So please feel free to submit any questions you have throughout the presentations today. You should be able to see a widget for that at the bottom of the screen. There'll be a short Q&A session towards the end of the hour where we'll be dealing with some of your questions. Please also check out the other widgets we have. There's a resources widget, which is filled with great content and thought leadership from LCD and Market Intelligence. And we invite you to give feedback via the survey widget. Lastly, please note that the activities of S&P Global Market Intelligence and LCD are independent and separate from S&P Global Ratings. S&P Global Ratings maintains a separation of analytical and commercial activities. So with that out of the way, we're going to start with a broader look at ESG, why it's commanding so much attention these days and why there might be so much at stake with ESG in the future. So for this, I'd like to introduce Lindsey Hall. Lindsey is the Head of ESG thought leadership at S&P Global Sustainable1. With all the focus on ESG these days, Lindsey has been especially busy. So we're very happy to have her here with us. So Lindsey, please start us off.

Thanks, Nina, and thanks for having me here today to talk at a high level about the rapidly evolving ESG and sustainability world. I'm going to start with a very high level, 30-second, 10,000 foot view, what is ESG, just to get us all on the same page. So in 30 seconds, ESG refers to the way that companies and investors are thinking about issues like the environment, climate change, gender diversity, workplace safety and culture and running their business in a way that's sustainable in the long term. Now this topic has been around for decades, and in particular, in Europe, but it's picked up a lot of steam in the U.S. over the past couple of years as well as in other parts of the world. A lot of times, you'll hear it referred to kind of interchangeably as sustainable investing or responsible investing. And again, it used to be more of a fringe idea, but now it's increasingly relevant to all industries. One thing we still hear a lot from clients and readers is so what? Why does ESG matter to me? And for one thing, the reason is there's big investor money at stake. So we've got asset managers, some of the largest in the world, your Vanguards, State Street Global Advisors, BlackRocks, deciding where to invest trillions of dollars of client money, and they are increasingly demanding ESG-compliant policies. To give you an example that's really widely cited in the ESG world, at the beginning of last year, BlackRock CEO, Larry Fink, came out with this pretty explosive letter to companies around the world telling them that they have to pay to attention to climate. And then he followed up 6 months later by taking action against management teams at companies that BlackRock found weren't making enough progress on climate issues. So siding with shareholders on their proposals, voting against board members and raising governance concerns. BlackRock also supported -- you might have been following in the news, the recent move at Exxon to oust Board members and replace them with activist investors because, again, BlackRock and other investors found that Exxon was not moving quickly enough on climate change. And so I just wanted to share this chart with you because we have seen such rapid growth in sustainable investments just over the past decade. Sustainable investments in the U.S. have surged more than 450% since 2010. And that's according to the US SIF Foundation. And then I want to just briefly give you some of the high level topics that we at S&P Global Sustainable1 are really focused on in 2021. One is the path to net 0. So how are companies going about cutting their carbon footprint, decarbonizing their business, offsetting those emissions that they can't get rid of altogether. Social equity is another, like I mentioned earlier, it's this idea of how are you treating your workforce and ensuring their safety, how are you ensuring diversity in your management team and your Board? Sustainable finance, I'm going to get into in a little more detail, but we've seen huge growth, and we see huge room for continued growth in sustainable finance. And then obviously, all this is sort of underpinned by disclosure standards, which is something that's still really evolving as companies and investors figure out how to report on, how to measure sustainability. And then climate risk is obviously a huge one. And tied to climate risk, we also have this growing focus on biodiversity and nature, which I'll get into a little bit more. So let's start by talking about this data disclosure piece. Data and disclosure remain patchwork, and that's been a big challenge for investors around the world. This lack of standardization is seen as a challenge, also as an opportunity. Since ESG is still pretty new in a lot of parts of the world, that means a lot of us are still struggling to define it and to measure it. And investors need this data to make decisions about which companies to invest in, which companies meet their green or sustainability investment strategies. And so you've seen this move of data providers coming in and competing to fill the void in ESG information by creating ESG scores and platforms to track and measure ESG metrics. This is something that's still very much in flux right now. And then you have a lot of groups globally that are working to measure and standardize ESG metrics. The 2 I have on this slide are 2 of the most prominent and recognized. One is SASB, the Sustainability Accounting Standards Board, and the other is TCFD, the Task Force On Climate-related Financial Disclosures. Just last week, we actually saw the launch of a new initiative, which is called TNFD, the Task Force On Nature-related Financial Disclosures. And that is seeking to help companies and investors measure growing risks related to nature. And so in this environment, we're seeing U.S. regulators taking an increasingly active role in ESG. Climate change is increasingly seen as a threat to the U.S. economy. And just to give you a couple of examples of how we're seeing that manifest in 2020, we saw this report commissioned by the CFTC's subcommittee, which called climate change a "major risk to the stability of the country's financial system and the broader economy." And this is a real sea change for regulators in the U.S. For the first time in 2020, the Central Bank, the Fed, cited the threat of climate change in its biannual financial stability report and said it expects banks to address systemic risks posed by rising global temperatures. Today, a lot of the discussion about regulating ESG, especially in the U.S., has centered around the largest institutions. But we're still seeing a lot of smaller institutions grapple with how do they get up to speed with what appears to be growing -- the growing tide of regulation. Because it seems that regulation and disclosure requirements are on the horizon. We've seen the SEC be extremely active on ESG in 2021. And I'll just read you this quote, which I thought was pretty telling from the -- then acting Chair of the SEC, Allison Herren Lee, back in March. She said that human capital, human rights, climate change, these issues are fundamental to our markets and investors want to and can help drive sustainable solutions on these issues. And she said SEC has been laying the groundwork for more progress to come. Another example, just in March this year, we saw Treasury Secretary, Janet Yellen, say that the Financial Stability Oversight Council, FSOC, is going to take a harder look at just how prepared financial markets and institutions are for a "rapid transition to a net 0 carbon economy." And then just in May, so just last month, we saw Joe Biden issue an executive order on climate-related financial risks. So there's a lot of activity in the U.S. and there's also just a ton of activity in Europe. I could spend hours on European ESG regulations, but I'm going to just highlight 2 here since I know we're limited on time. One is the EU's green taxonomy. So investors and banks have less than a year to comply with the EU's new taxonomy for sustainable activities. And starting in January of next year, investors have to explain both how they use the taxonomy to assess the sustainability of their investments. And then also, they have to disclose what percentage of their investments align with the taxonomy. And so this is expected to radically change how investors and companies report or disclose their environmental performance. Another new regulation and another acronym for your ESG vocabulary that we're hearing a lot about is SFDR in Europe, which is the Sustainable Finance Disclosure Regulation. And this is new disclosure regulations that just came into force in Europe in March as part of this EU push toward making the economy greener. This too is expected to have a drastic impact on the scope of sustainable investing by providing more clarity, more transparency, more disclosure. And this means fund managers are now going to have to disclose environmental, social and governance risks in their portfolios, which is, again, the first step in a much broader EU plan to drive capital towards sustainable goals. Briefly just touch on the rising focus on S. A lot -- so far, we've talked a lot about the E, the environmental in ESG, but there's been a big push toward the S, especially since COVID -- COVID-19 pandemic. So human capital management or the way that companies treat their workforce has long been a part of the S discussion. But with COVID, you saw a lot more companies and investors focusing on how are we ensuring worker safety and how are we ensuring the safety of those in our supply chains and in our communities. Gender diversity has been a big focus for investors for several years. But in the last year, we've also seen a lot of corporate America focusing on different kinds of diversity and, in particular, on race and how do you fight systemic inequality and systemic racism. And so we're seeing investors increasingly taking action on these S issues, which is causing a shift in company strategy and priority. And then when it comes to just tracking or measuring the E in ESG, many companies are moving to renewable energy sources, working to achieve net 0 emissions. When we talk about net 0, what we mean is cutting as much emissions as possible and then finding ways to offset the rest. And you're seeing a lot of banks around world setting net 0 goals and changing the way they lend. To give one example, the big French bank, BNP Paribas, has been really at the forefront and expanded its commitment to exit coal worldwide by 2040. The bank has been working with clients to help them exit coal and other fossil fuels and transition to renewable energy sources. But importantly, the bank also acknowledges that not everybody is going to manage that transition. Cutting Scope 1 emissions is relatively straightforward for lenders. But the real challenge often comes when you're figuring out how do you cut the emissions that you're financing. And then I just briefly want to wrap up by talking about the outlook for sustainable finance. Because as I mentioned at the beginning, this is another area where we're seeing a lot of growth and change. According to one estimate, limiting global warming to 2 degrees Celsius by 2050, in line with the Paris agreement on climate change, is going to require $3 trillion annually. And annual investment in low-carbon energy technologies and efficient energy efficiency will need to increase by a factor of roughly 5 by 2050 compared to 2015 levels. So just there's a huge gap or demand. And according to one estimate from our colleagues at S&P Global Ratings, transition finance could provide up to $1 trillion annually over the next 30 years. We've seen -- just to give you a couple of numbers, green finance growing exponentially in the last couple of years and appears poised to continue that growth. Green bonds, which is debt that finances environmentally friendly projects like wind farms or solar power. That's grown rapidly over the last 8 years. It was virtually nothing in 2012, and it was more than $280 billion in 2020. We're also seeing, especially mid-COVID, this big growth in the issuance of social bonds. Those are debt instruments that finance projects like affordable housing, health, education, other social needs. And that grew in 2020 to more than $162 billion, up from just about $18 billion in 2019. So significant growth. And then finally, sustainability bonds, which are sort of a hybrid of the social and green bonds. And those grew to more than $136 billion in 2020 from just about $41 billion in 2019. So there's obviously a ton more that I could talk about, but I want to make sure we have time for all our other panelists. If you would like to learn more, S&P Global has both a podcast that I cohost called ESG Insider. You can find it on Soundcloud, Spotify and Apple Podcast. And we also have a weekly newsletter where we cover all of these evolving ESG issues. And with that, I think I will turn it back over to you, Nina.

Thank you so much, Lindsey. That was really great, really insightful. We're going to have a little dive now into leveraged finance itself, including a look at how ESG deals are being structured and shopped to investors and then a view of ESG from a capital markets perspective. First of all, I want to give you a little bit of a view into the sort of deals that we've seen to date. So some of the deals that Lindsey was talking about green bonds, green loans, social bonds, we've actually seen those in the market in the leveraged space, non-investment-grade sector since 2014. So they're a fairly familiar structure. These are transactions where the use of proceeds has to be put towards green or sustainable projects or uses of proceeds. And that's as specified by the International Capital Markets Association. But something new that's emerged in the last sort of 18 months or so has been sustainability-linked financing. In the European market, the first one we saw was late in 2019 from a firm called Jeanologia. Carlyle was actually acquiring a minority stake. Excuse me. Now Jean's production is quite water heavy. So this firm, put a margin ratchet onto its term loan where it's said, okay, if we set up a target for saving water, and if we hit that target, there will be a cost saving for us on our term loan. And if we miss it, there will be a penalty for us as the issuer on our term loan. So that was basically late in 2019 and that was quite innovative at the time. But actually since then, the number of margin ratchets, ESG-linked margin ratchets, unleveraged loan, has grown exponentially almost. So we've seen a number of transactions so far this year with a similar structure. Just out of market this week, you've got a deal from Noveon, which is a base chemicals firm. That has ESG language linked to a margin ratchet, and also Virgin Media Ireland is out within the market with a transaction with the same sort of structure. At base, that's based around 3 KPIs that it specified. Now on term loans, it's normally a positive or negative margin ratchet. So the margin steps up if the issuer misses it's target; steps down, if it hits it. And then linked between 1 and 5 KPIs normally, it differs really between issuers, in line with the with the leveraged loan product itself. It's quite flexible, it's quite bespoke. And you've seen similar things on -- with ESG-linked Schuldschein and euro tranche financings. In the high-yield bond market, it's been a much more recent development. In Europe, we saw our first one only in March. I'm going to come back to the high-yield market in a second. But the structure there is slightly different. It's only a punitive coupon step up. So the issuer will set a target and if it misses the target, then there's a step up. There's no sort of benefit available to the firm if it missed -- if it hits its target. And something else we have seen in loans is where a couple of deals have had margin ratchets linked to third-party ESG scores. So the Asda buyout earlier in the year, that was a big one on that, where there's obviously a margin rachet linked to a third party score provider. And as the score moves up and down, then the margin moves up and down in the same way you would have margin ratchet linked to a credit rating. And one other thing I wanted to mention was revolving credit facilities. So we've seen quite a lot of revolvers, where there's a KPI linked to margin ratchets. There's a new deal out in the market just this week actually from a firm called Nomad Foods with a high-yield bond and an institutional term loan. There's no ESG language as far as we're aware as yet on the term loan or the high-yield bond. But there is actually a KPI linked to targets on its revolver, which has been increased. And then something else which was very interesting, where there was a company called Acrotec earlier in this year. And they actually did a revolver where the margin was linked to the use of proceeds. So if the company was drawing down for any sort of normal general corporate purposes, there was one margin. But if it was using it for green use of proceeds, then there was a bit of a margin saving for that firm. I mentioned this was going to be interactive today. So this is the first question for you, our audience. I want to get your own insights into how interested your firm is in green and sustainable investment segment. You should just be able to vote on the pop-up that's coming to your screen now. I'm going to give you a few seconds. Whether you're not particularly interested, whether you have a significant interest, whether this is mandated and that you really think this is going to be the future of the market, if I could just ask you all to vote now. [Voting]

Okay. Let's see where those come up. Okay, that's interesting. So 37.5% of you think there's significant opportunity coming at -- coming up in the future. And actually, almost a third say this is going to drive the market eventually. And well, that's good to hear for us who are pretty involved at the moment. I mentioned I was going to come back and talk about the high-yield market in more detail. As I mentioned, the first high-yield bond that we saw in Europe anyway that had a sustainability-linked pricing, where there's a coupon step-up linked to an ESG KPI, it was only in March. It was Greece's Public Power Corporation. And you can see already, since March, we've had sort of an explosion in the market. So just since March, and this is only to May the 12th this year, there was $3.01 billion of sustainability-linked notes completed. And as Lindsey talked about, there has been a step-up in green bond issuance, too. So green bond issuance, just for the first 5 months of the year was at $2.58 billion this year, up from $1.97 billion across the whole of 2020. Now this first transaction from Public Power Corporation. I'm going to just talk about that for a moment because it went extremely well. So it was a EUR 650 million transaction. That was actually increased from a planned EUR 500 million. They came back 10 days later and they tapped that bond, and they got away with another EUR 125 million. Again, that was increased by a planned -- by EUR 50 million from what they had planned. So that really shows you that the depth of demand and interest for this product. Now we don't have, as yet, the depth of data where we can carve out all the transactions in this sector, both high-yield or leveraged and say, okay, let's look at the pricing as a whole. But what we can do is look at individual transactions, compare them versus other deals of that rating and that structure. And we are seeing a little bit of a pricing premium or greemium for sustainability-linked transactions. So for example, looking at other transactions of the BB-, around the same time as Greece's Public Power Corporation came. So the average yield with the same rating was about 4.89% whereas PPC's original deal came at 3.875% yield, and the add-on came at 3.709% yield. It should be said that I don't think arrangers or issuers anywhere in the market would be proposing this of, oh great, let's pop some ESG on there. Let's put some green language in there, and we can save 10, 15 basis points. It's very much has to be right for the issuer and has to be bespoke for the issuer. There's a real push to make sure that these KPIs that are utilized are relevant, are ambitious and are meaningful. Investors are increasingly aware of where there's greenwashing, where there's targets being put in place where the issuer is already in the money, so whereas the target will be hit from day 1. And both LFA and the LMA, which is the European Leveraged Finance Association and the Low Market Association, are now working on guidelines to make sure that the targets that are set for these transactions are relevant, they are ambitious and they are meaningful. But as I show you this data, you should be able to see how much this market has come on just in a few short months for the high-yield sector. So we have 15% of the deals seen to May the 12th, that's by deal count, have some element of ESG on them. And that is 8 sustainability-linked notes. This is just between March and May 12 and 7 green bonds, that's up from 4 in the whole of last year. Now all of the transactions that I've mentioned, and in fact, everything that has an ESG element on it across the non-investment-grade sector can be seen in ESGs -- sorry, LCD's new ESG tracker. This is available on our website. So it covers everything, every green bond issued, every sustainability-linked bond and loan. It's updated weekly. So it's kept up to date. And you can see everything on there. So not only the size of the deal, the use of proceeds but everything we know about the KPIs that are utilized, the size of the ratchet and everything like the sustainability agent that has arranged the deal. Also on there, although you can't actually see from the screenshots I have just there is the sponsor on the transaction. And then I have one of the sponsors that has been involved in a lot of deals to date is Carlyle. And I'm very glad to be joined now this afternoon by Sam Lukaitis, who is a Director of Global Capital Markets at Carlyle. And he's been one of the names that has really been innovating a lot of these structures that you've seen over the last 18 months or so. I mentioned a couple of Carlyle's deals already. And so thank you so much for joining us this afternoon or this morning, depending on where you are, Sam, and for talking -- for talking to us with this webinar.

No, my pleasure. Thank you, Nina.

So my first -- my first question is looking at this, how we've seen this market develop, as we talked about. Why have ESG-linked financing increased so much in the last 12 to 18 months? What's really driving the changes in the sector?

I think it's a very good question. We tend to think about that the other way around, maybe why did it take so long for very well-established in the corporate and investment-grade debt space to make their way into the sponsor ecosystem. We've had green bonds since the '90s, I think. Private equity sponsors now account for a huge portion of debt issuance globally. And it sort of, I guess, begs the question why it took so long for some of these themes to come across from corporate land into sponsor land. But I think over the last 12, 18 months, we've had a -- it's been a pretty unique time with the pandemic and a huge focus on social issues and sustainability. And I think it's really just a bit of a confluence of the 2 things. It was probably long overdue. And then I think the pandemic and the -- some of the social issues that have been brought to light throughout that period of being the catalyst.

Okay. That's -- yes, that makes sense. I mean, we saw from the audience poll that people see there's going to be a significant opportunity for growth in this sector. What are your thoughts on that? I mean, do you think that these structures are going to become widespread across the market? Or do you think it's only ever going to be niche for the borrowers or who are working those in now? Sam, I think we can't still hear you, even if we can see you. Nope. Well, while we are working to get Sam back online, I hope I can perhaps just skip ahead a little bit. I'll come back -- well, actually, first of all, I'm going to come to a second question for the audience, which is what for you is the largest impediment for your firm participating in green sustainable leveraged finance? Again, I hope you can vote just by clicking on your screen. Is it about unfamiliarity with the segment? Is it like a standardization? I know, Lindsey talked about that for a little bit. Is it about the potential for green washing? Is it about insufficient deal flow or the uncertainty regarding regulations? Just give you a second to vote on that one. [Voting]

And let's see. Okay. We'll click off it now. That's very interesting. 66.7% are concerned about the lack of standardization. And so far, no concerns about greenwashing, which is interesting. Sam, I think we have you back?

Yes, sorry.

No worries.

I'm not sure what happened.

Don't worry about it.

Whereabouts were we, Nina? Beginning, middle or end?

Well, let's maybe -- we just asked the audience of what their concerns were about sustainable financing. So talk about the lack of standardization, but also greenwashing. I mean, do you think we're going to have to see some standardization coming into the market? Or do you think it is going to be always sort of more bespoke and more individual to issuers?

I think there's definitely standardization coming. There's a big push for independent verification of ESG metrics and differing views around this. I mean, I think there have been a couple of cases of people more focused on the sort of PR marketing exercise of "green loan or bond" versus it being particularly material for the business. And what they get, they get scrutinized by accounts. And people talk about them and write articles about them, and I think there's a lot of feedback that comes from the credit world on these topics. And that going forward, issuers are going to be mindful of that. So whether or not we have full standardization and third parties verifying whether or not metrics have been complied with, I think issuers now know that there's a very broad audience here and people are watching. And people aren't going to get away with sort of -- slightly sort of nefarious sustainability-linked loans and bonds they've kind of dreamt up last minute for PR purposes versus it being a genuine target of the company.

How are credit investors' reactions to these transactions? How have they developed? I'm thinking specifically about sustainability-linked transactions that we've seen. How they changed since -- when you were first doing these deals back in late 2019 to where we are today, where it seems like they've become much more mainstream, especially in the European market.

Sorry, you said their expectations about what kinds of deals...

Yes. And also like interest in the deals. Yes.

Yes. I think they've been interested for a long time. On the issuer side, on the private equity side, we're fortunate to be in control of our companies. And we can change policies and change managerial teams and so on. I think the credit investing world has been interested in these topics for a long time. The first thing for them is probably to get the disclosure and actually understand where does this company sit on the spectrum, how is it doing versus the peer set. But then I think having ESG elements brought into financings and creating that sort of dynamic approach between the issuer and the creditor and do you think this is a credible ESG metric, would you be willing to pay for it if we're successful in hitting that target, I think the reception has been really good. Point #1 is the disclosure. People need to understand how to think about individual businesses in the markets that they exist in. You can't really draw a whole load of comparisons between one of the oil majors and a very lean tech company that has 5 employees and very little real estate and so on. But getting the disclosure, understanding how it sits across these metrics versus the peer set and then saying, do they want to reward management teams, the sponsor with a financial incentive, if they hit certain targets, and I think it's been a really good dialogue. I mean a lot of the accounts we've spoken to on this topic have sort of made the point. We want the disclosure to understand what we're doing and how to think about all this stuff. And then secondly, we do like the kind of ESG metrics in the sense that -- it makes it less of a passive experience for accounts. They can -- they can incentivize them a meaningful ESG-related change in the business.

I'm very interested. As we see disclosure and these issues about disclosure adopted by more and more issuers across the market and understood and sort of really accepted by more and more issuers in the market. Do you think we're going to see many more issuers incorporated -- incorporating ESG-linked pricing structures into their transactions? Or do you think this is always going to be something that is only right for specific firms? How big do you think this market could potentially be?

Very, very big, very big and growing. And my subjective view is that the economic incentives around this stuff are going to become larger over time. But yes, no, I think it's here to stay. And 9 times out of 10, you can find a company that's either doing well on the ESG path that you can incentivize it to do better. So these are concepts that are applicable to people who are already performing top quartile from an ESG standpoint and also that are performing bottom quartile. I think to the extent people are focused on improving portfolio company performance, this can be applicable to the -- yes, the companies that picked up these topics a long time ago and the people who are just picking them up now. And I think that is applicable across sectors as well. So businesses that have a very heavy carbon footprint that are trying to transition and be cleaner and so on, ESG is super relevant for these guys. You don't look at a company like that and say, well, that's an old school oil and gas business, ESG is lost on it. I mean that's the -- arguably, where you make the most amount of change in the company. So I think it's very relevant and growing but growing for the right reasons.

Great. That's interesting. When you're looking at individual issuers, whether they're sort of very much at the green end of the spectrum or very much perhaps the brown end, how do you look at KPIs that you can link to a margin ratchet or to a coupon step-up? And how do you make sure that they are fair and relevant and right for the issuer?

It's a good question. I think it's always -- you need to start in the particular market, and you need to compare that company against its peers at what is it doing well, what can it improve on and so on. But making these cross-sector comparisons is not -- for me, personally, it's not particularly sort of useful. Indeed, when you look within the ESG metrics, I mean, it's a good thing that you have companies that employ a lot of people from -- in terms of just society functioning well. That's a good thing. Those companies are going to have, in general, largest CO2 emission profile associated with them, given the headcounts and so on. So I think it's always important to look at the company within the context of its sector, compare it against its peers. But we've always tried to find things that were quite unique to a company. So you mentioned Jeanologia. The electrical and water savings associated with that business model is the reason we invested in it from a financial perspective. That's the reason it exists because it's a disruptive technology. Similarly, Logoplaste, which happens to be a packaging business, this is something that was -- had a completely different model to its competitors. It was doing everything on side of the customer and avoiding driving lots of heavy liquids around through Europe and huge emissions associated with that thousands of tons of, I think, 7,000 or 8,000 tons of CO2 per year. So -- and again, that was the reason why that company exists in the first place because it was differentiated versus the off-site packaging businesses. That's why we invested in it from a financial standpoint. So these are sort of unique things. That's what we've tried to focus on. Things that are really part of the business and finding a confluence between financial objectives and sustainability objectives. And that's not always necessarily easy to do, but we have been fortunate to have companies where those 2 things are very aligned, and we've tried to promote that, bring it into the capital structure, set meaningful targets around it, have a risk-reward system, engage with accounts. Do you think we can hit this target? Do you agree it's a good thing? And so can we be rewarded? If not, we're happy to pay a highly slight -- a higher cost on our debt. So yes. And for me, personally, it starts with the business and looking at its model, thinking about the sector.

With that in mind, what do you think is the role potentially in the future of third-party score providers?

Good question. So our leveraged finance world has always been really a self-certification world. So we come up with a perspective on EBITDA, covenant compliance and that sets the leverage ratio for the margin ratchet and so on. So that's the world we've always lived in. We've absolutely always had third parties rating our debt issuances, like S&P and Moody's and Fitch and so on. But in terms of the day-to-day, that has been done by us with the management team, worked very well. I think where -- we have set some targets that are not incredibly difficult to calculate, whether or not they're hit, it's not sort of -- you don't need a PhD and some sort of niche-y science to kind of get to the bottom of all of that. And some of these targets are very binary. You're either on the right side of the line or not. And as an issuer, we feel pretty comfortable. We're grownups, we have fiduciary duties or certainly, our management teams do to record that, compute it, and let the market know where we stand in the same way that we do with the leveraged component and how that impacts the ratchet, at least on the loan product. So I think in that scenario, it can work quite well. And we feel as though we're sophisticated enough to figure some of these things out. Where they -- where the metrics and the calculations are specialized, if that -- if that is going beyond the expertise of management, I think there's a very legitimate reason to have a third party involved and looking at that and assessing it and helping us. But yes, what we have found is that we are, for our own investors, our own LPs, we're really focused on how these things are calculated. And we're sort of right in the weeds with all the data and figuring it out ourselves. So, I guess, in conclusion, we would say sometimes, we feel we can do that perfectly well, and we do it with a lot of integrity. On other occasions, we can totally understand that things might be quite specialized, and it's quite useful to have a specialist assisting with these calculations.

And one final question, just quickly. We heard a little earlier about the new regulations that are coming to both European and U.S. markets. How do you expect the market to develop in the future with these changes on the horizon?

Well, I think it's -- overall, there's a push to greater transparency, probably a move in the direction of independent verification. So I suspect that going forward, we're going to have a little bit more standardization. I think the standardization disclosure is great. It's very, very good. I think what is good also not to lose sight of is drilling down into the individual business and thinking about it versus its peer set, why it's different, is it sort of meaningful? Is it the kind of thing you should set an ESG ratchet to, for example? So I think focusing on the company and the industry and how it stacks up against its peers and then thinking about the disclosure and the standardization and what accounts are you going to inspect, I think for me, I think that's a nice way for this market to continue to mature.

That's great. Sam, thank you so much for your time this afternoon for us. I'm going to move on for a moment now to shift the focus to the performance of ESG yields, specifically in the high-yield segments. And for this, we are going to turn our attention to Martin Fridson. As many of you know, Marty is a pioneer in the world of high-yield analysis. He's also the CIO of Lehmann, Livian, Fridson Advisors. And we're very happy to say that Marty's analysis can be found exclusively each week on LCD and MI. Marty, I'm going to hand it over to you.

Great. Thank you very much, Nina. All right. Well, my research assistants and I set out to contribute to the ESG discussion by pursuing the question of whether investors are penalized by adopting enlightened policies on environmental, social and governance matters as some fear or whether doing so actually enhances performance as some ESG advocates maintain. Our laboratory for these investigations has been the U.S. high-yield market. We produced a series of LCD pieces based on our investigations and our initial findings were summarized in an article in the spring 2021 issue of the Journal of Fixed Income. I will also be reviewing a recent update of our research. Now the impetus for this particular line of research was ICE Indices' launch of ESG-based high-yield indexes in June 2020. The records for these indexes were created retroactively to the end of 2016. So we now have about 4.5 years of history on their performance. To design these indexes, ICE Indices uses ESG scores generated by Sustainalytics. So all of the issues in creating ESG scores that you heard about from the previous presenters will affect the results that I show you. As of now, these are the best tools we have available to determine the impact of ESG-conscious investing on performance. There are 3 versions of the ESG-based indexes that I referred to in these slides. The construction begins with the standard ICE [ view of a ] U.S. high-yield index. The ESG tilt index excludes all bonds of companies with significant involvement in controversial weapons. It then tilts the weights of the remaining issues in favor of a [ launch that's better ], which is to say lower ESG [ support ]. The second index does all that and then further adjusts the weights of these issues so that the resulting index matches the standard high-yield indexes interest rate exposure across rating categories and industry sectors. Finally, the ICE U.S. high-yield best-in-class ESG index eliminates both bonds of companies with significant involvement in controversial weapons and bonds of companies with high ESG risk. It adjusts the weights of the remaining issues to match closely the ICE BofA U.S. high-yield indexes rating and industry sector distribution. This table shows that over the 4 years ending 2020, all 3 ESG indexes outperformed the standard high-yield index in both absolute and risk-adjusted terms. But when we broke down those 4 years of monthly returns into up months and down months based on the price change on the standard index, we found that all 3 ESG indexes underperformed the standard high-yield index in the up months. So their outperformance for the full period was entirely concentrated in the down months. We further found that this happened to be a period in which the winning strategy was simply to be risk-averse. The BB index also outperformed the overall high-yield index, not only on a risk-adjusted basis but even in absolute returns. And it beat the standard index by a greater margin than the ESG indexes did. These sorts of results are period sensitive. In the 2010s, the BBs beat the riskier standard index in absolute terms, but BB has performed worse than the standard index in the first decade of this century. So we may find over the longer-term that the ESG indexes sometimes do better than the standard high-yield index and sometimes do worse, simply depending on whether it's a period in which it's advantageous to be risk tolerant or risk-averse. Now in the study described in this slide, we focused on the duration-matched ESG tilt index during the horrendous downturn of March 2020. That was the month in which financial markets reached a low point during the COVID-19 sell-off. The ESG index did about 250 basis points better than the standard high-yield index in this short period. But we also found that the ESG index began March 2020 with a lower exposure than the high -- standard high-yield index in the high-risk CCC and energy categories. So yes, the ESG index outperformed by 250 basis points in March 2020. But if it had the same ratings mix as the standard high-yield index, the ESG index would have done 170 basis points worse than it did. And if the ESG index had, had as much exposure to energy as the standard index did, that would have knocked about 70 basis points off its return. Now you cannot simply add the 170 and the 70 basis points together to get 240 basis points. Some of the energy bonds were rated CCC, so there would be some double counting if you follow that procedure. Still, it's pretty clear that a lot of the ESG index's superior performance in March 2020 was attributable to differences in composition versus standard index that were not a matter of including or excluding companies with bad ESG scores. And we'll see -- as we'll see a bit later, the differences in composition that helped in the bear market can hurt an ESG index's performance in a different sort of environment. In the next phase of our research, we said, let's take out the ratings of -- the effect of ratings mix and the energy weighting. Let's see whether bond for bond, good ESG bonds perform better than other bonds. We measured the returns in standard deviations of bonds in the 2 categories of good and bad ESG scores, matched credit rating for credit rating and leaving out all energy bonds. Once again, our observation period was March 2020. Now in this version of the analysis, we found that at 4 rating levels, there was no statistically significant difference in performance between bonds of companies involved in controversial weapons and bonds of companies not involved in that activity. At 6 rating levels, there was a significant difference in return. But in 2 cases, the weapons bonds did better. And in 4 cases, the nonweapon bonds did better. So there was no clear verdict on whether you were better or worse off lending to [indiscernible] producers. Now we got similar results when we broadened it out to issuers with bad ESG scores for any reason, bad governance, antisocial behavior or whatever. In most of the rating categories, it was a toss-up. In the 3 categories in which made a statistically significant difference, you did better by owning bad citizens in one case and worse in 2 cases. So again, no clear verdict. Finally, in this line of inquiry, we studied the energy bonds that had been excluded from our previous analyses. Sustainalytics gives a few high-yield energy bonds good ESG scores. So we pitted those companies' bonds against peer groups matched by rating, maturity and subcategory within energy, i.e., E&P, services, pipeline or integrated. 5 of the good energy companies outperformed their peer groups in March 2020 and 7 underperformed. So yet again, a nearly even split and no basis for saying that adhering to ESG principles either helps or hurts performance. Bear with me just a moment. I'm sorry.

Hi. I can't move the slides.

Okay. I'm sorry. This -- okay, I should be on the total return comparison, December 31 to...

[ Tightening ].

Yes. Okay. I'm sorry. Now my last slide presents the results of a recent update of some of our research. Year-to-date, through May 7, the duration-matched ESG tilt index underperformed the high-yield index 1.90% to 2.29%. But when we re-weighted the standard index according to the ESG index's concentration in energy, the difference in performance disappeared. The re-weighted standard index returned 1.91%. So in contrast to the March 2020 results in which a low relative exposure to energy was an advantage for the ESG index, this year has been a disadvantage, and that's because energy has outperformed the rest of the high-yield universe by about 575 basis points. And energy is the largest industry in high yield. At this point, we have to conclude that at least as far as the high-yield asset class is concerned, the reason to follow an ESG discipline is not as a means to achieve superior total return. You do it because you want your investment policy to reflect your convictions about the environment, social practices and corporate governance. And as far as the available evidence tells us, there's no strong reason to believe the market will penalize you for putting those principles into practice. Thank you for listening, and I'll now turn it back to Nina.

Thank you so much, Marty. That was some really interesting analysis there. We have one more audience question for you, which is a [ purpose in plan ]. Versus your last piece of interactivity, would you like to be contacted to learn more about LCD solutions and/or thought leadership? Just a couple of options here, yes, please contact me to receive a demo of LCD solutions; yes, I'd like more information about LCD or thought leadership; or no, thank you. If you could just respond to that one, and then we will be moving on to the Q&A portion just for a few minutes. [Voting]

Thank you so much. So we've had some really interesting questions in from the audience over this, the course of the last hour and submitted beforehand. And one of the first, actually, I was hoping to come to you on this one, Lindsey. Do you believe the investor community truly believes in ESG factors? And if so, how do they balance return on investments and ESG impact in their performance metrics?

Thanks, Nina. That's definitely an interesting question. And I'd say it's difficult to generalize about investors, but I do think it's safe to say that generally, they're seeking to grow their money, and so I think investors would not really be embracing ESG if they didn't also see room for returns. And at this point, there have been many, many studies from both the business and academic worlds that demonstrate a positive correlation between ESG policies and company performance. And the idea, I think, is that ESG, when it's done right, means that a business is more viable and sustainable over the long term. And that really aligns with this huge shift in investor attitude that we've seen in recent years, away from short-term ISM and towards a more long-term view. So I think probably investors see ESG as a way to -- many investors probably see ESG as a way to do the right thing when it comes to climate or diversity or social equity as well as governance. But I don't think it's done in some starry-eyed naive way either. I think they're also embracing ESG because they see it as the necessary thing to do to protect their money.

Interesting. Thank you. I wonder if I also may come to you. I know you mentioned in your presentation about the developing role of social, of the S in ESG. And we've had a question come in, in response to sort of talking about greenwashing. It's easy to say that people are watching. And this may apply to the E parts of ESG. But what about the S part? There's a concern that social responsibility is less objective than environmental responsibility.

Yes. I think that, that's a very good point. At this point, we're struggling for data or requesting for data across the ESG spectrum, but the S is particularly tricky. Especially when it comes to things like race, it's really difficult to measure. The data doesn't often exist. But there are things that are in play that are important to mention and I'll do so briefly. I know we're almost out of time. The -- I mentioned the existing green taxonomy in the EU. Right now, there's also a social taxonomy being debated in the EU, which would effectively be the S version of that green taxonomy that already exists. I also talked about the new sustainable finance disclosure regulation or SFDR in the EU. SFDR considers social characteristics such as lack of board diversity as a potential adverse risk. So I would just say there are things that are in-flight in the U.S. as well that work to address the S. But I think that, that is definitely an area where we'll continue to see growth and change.

Thanks so much. And we've had a lot of actual questions about the pricing benefit to your issuers to borrowers through issuing ESG-related debt. Sam, I'm going to ask you sort of an exact number in terms of specific -- basis points saved or percentage points on the yield saved by issuing through ESG. But as a whole, across the whole market, have you noticed that there may be a benefit to issuers whether that's sort of a quantitative one or a qualitative one?

I think so, for sure. I mean, yes -- yes, there are both. I mean in terms of the economic impact, maybe if we compare it to the leverage ratchet, we're typically moving 25 basis points per 0.5 ton of leverage or deleveraging. But the sort of ESG ratchets have tended to be around sort of 10, 15, maybe 20 basis points either way. I mean, across a big portfolio, I mean, these things do add up. It could be 10, 15 basis points of cost saving does start to accrue. But qualitatively, yes, definitely. We are doing this because we believe in it because our investors are super focused on it. And it's a nice way for us to demonstrate that to the world and externalize it a little bit more, bring it into the credit markets. We feel like we've had this big dialogue with our LPs and the equity side about ESG going back quite a long time. It's good to kind of have that out in the broader market. And I think people do understand some of the deals I mentioned before, Jeanologia, Logoplaste, Flender is another one that we've done recently in Europe, that there is a real confluence of sustainability and financial performance on these deals, which is a message we are -- we do like to get out there. We certainly kind of believe in that side. Whether or not the cost saves overall will become more material over time, I suspect they will. Just because there will be more green issuance and the portfolio effects and these things really do kind of add up. But I can see differentiated pricing as well dependent on the story. So maybe there's a lower ESG ratchet for one company and a higher ESG ratchet for another company because it's doing something that is far more kind of impactful. I think it will sort of grow in importance over time.

Thank you, Sam. We're just coming -- just past the top of the hour at the moment. There was another question that popped up asking if a transcript of today's webinar will be available. And I can confirm that there is a replay available within 24 hours and then a transcript will be available within 24 to 48 hours in the related content widget on this page. So I would like to thank all of our presenters and guests today, Lindsey Hall, Sam Lukaitis, Marty Fridson. And thank you to you all for viewing the webinar, and we hope to see you next time. Take care.