Sun. Nov 28th, 2021


A strange paradoxical feature of current markets is how global capital manages to be both supportive and subversive of the environmental, social and managerial agendas that are a central focus of investors’ attention around the COP26 Climate Change Summit.

Equity funds with socially responsible investment or ESG mandates have attracted twice as much money as their peers without it so far this year, according to data provider EPFR.

Yet this pursuit of decolorization and social responsibility, which is as much an asset management marketing ploy as a sign of virtue, is primarily a stock market phenomenon.

In the much larger global bond market, BBVA Global Markets Research has estimated that the stock of green, social and sustainable bonds at the end of 2020 had not yet reached $ 1tn out of a market total of $ 128tn. While this green exposure is rising rapidly from a low base, it is undeniably small.

The vast majority of this market is ethically value-free. ShareAction, a non-profit responsible investment group, found last year, for example, that 84 percent of asset managers had no public policy against purchasing sovereign bonds from countries under international sanctions for human rights abuses.

One consequence of this in the fund management fraternity is that global capital rewards China, the world’s biggest polluter and a country that has been criticized for human rights. Despite increasing geopolitical tensions between Washington and Beijing, foreign direct investment in China is at record levels, while inflows into Chinese debt reached $ 186 billion in 2020.

Even after the market’s shivers of regulatory risk stemming from Beijing’s “common prosperity” agenda and rising default in the real estate sector, foreign holdings of Chinese bonds rose by about 30 percent in 2021 to more than Rmb3.9tn, according to central bank figures .

For debt investors, the bait lies in the fact that the Chinese sovereign debt market has long been offering a significantly higher return than the US treasury market. With much lower inflation than in the US, real yields on Chinese government bonds are also positive. So for global investors, the search for returns trumps ESG considerations. At the same time, the progressive inclusion of Chinese bonds in the major global indices ensures that passive fund managers who follow them are pouring more and more money into China.

The ESG sensitivity of the global bond market is nevertheless going to increase as the advanced country central banks commit themselves to greening the portfolios of bonds they have acquired through their asset buying programs.

China’s currency regulator figures show that central banks are responsible for $ 264bn of the outstanding $ 512bn balance of foreign – owned Chinese debt.

The Chinese government debt market is relatively illiquid as the commercial banks that are the main participants in the market buy and hold until maturity. Such rising central bank exposure reflects a growing trend to prioritize diversification and the pursuit of returns over liquidity and security.

It also suggests that central banks such as the European Central Bank and the central banks of the euro system holding renminbi-denominated assets could be caught in an internal green-brown carbon conflict.

Policymakers at COP26 have been looking for asset managers and owners to do much of the work on decarbonisation, both in terms of financing the refurbishment of the carbon-intensive capital stock and pushing companies to pursue net zero emissions. Yet there is a limit to what they can do, as many large greenhouse gas emitters are state-owned or private and therefore do not owe much to institutional investors.

In addition, fund manager BlackRock CEO Larry Fink warned that pressure on public companies to pursue net zero targets – while leaving individuals out of the spotlight – creates an opportunity for “the biggest capital markets arbitrage in my lifetime”.

He has a point, although the transfer of dirty assets from public to private equity also poses the greatest regulatory risk on the planet. This is because it is unlikely that the goals of Paris and Glasgow will be achieved without more widespread use of carbon prices that will seriously harm the value of dirty assets. Yet private equity executives know that carbon prices and stricter regulation of heavy emitters are politically charged. Their listing of listed companies’ carbon-intensive assets may therefore continue for some time to come.

john.plender@ft.com



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