Companies on track with decarbonisation face higher borrowing costs: MSCI
Study finds that issuers that are partially or fully on track in meeting their climate targets have a spread premium of between 6.9 and 11.4 basis points compared with those that are not on track
[SINGAPORE] Companies that are at least partially or fully on track in meeting their decarbonisation targets are found to experience a widening in their corporate bond spreads on average, compared with issuers that are not on track, indicated a recent study conducted by index provider MSCI.
However, the study also found significant divergence between different sectors. For example, companies in hard-to-abate sectors that were aligned with their climate goals saw significant spread tightening over one and five-year horizons.
Companies that have put in place climate targets are also found to have lower borrowing costs, exhibited by a lower spread in their corporate bonds, compared with issuers that have not established any of such targets.
These were MSCI’s findings after examining the bond spreads of close to 2,900 corporate bonds denominated in US dollars.
Higher borrowing costs for companies aligned with climate targets
After controlling factors such as sector, credit rating, duration and liquidity were taken into account, the study found that issuers partially or fully on track in meeting their climate targets had a spread premium of between 6.9 and 11.4 basis points compared with those which were not on track.
“These results suggest that bond markets may impose a transition risk premium, reflecting costs, uncertainty or execution risk associated with decarbonisation,” said the report.
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The same effects were seen even when the study looked at how corporate bond spread changes based on a rolling one-year, three-year and five-year horizon.
Companies that were fully on track experienced a spread widening of 7.3 basis points over a five-year period, compared with issuers that were not on track.
For companies partially on track, the spreads became larger over all three time horizons, compared with those that did not meet their targets at all.
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“These results suggest persistent market scepticism. Bond investors appear to require credible, observable and sustained progress rather than responding to announced targets alone,” said the report.
However, when the study factored in the emissions profile of these companies, issuers that met their climate goals were actually rewarded.
Issuers with higher emissions intensity that met their climate targets saw lower corporate bond spreads, which is “consistent with market recognition of credible decarbonisation among high emitters”.
High emitters that only partially met their climate goals, however, faced higher borrowing costs.
“(These) suggest that transition risk is priced asymmetrically based on both emissions exposure and execution credibility. High-emissions firms can benefit from credible progress, while firms lacking full alignment face spread penalties,” stated the report.
“Investors do not simply price decarbonisation ambition, but rather differentiate based on both baseline emissions exposure and execution credibility over time,” said the report.
The study also found that investors priced decarbonisation commitments differently based on their sectors.
Issuers from high-emitting sectors such as materials and energy, and were also on track in meeting their climate targets, saw spread tightening.
Companies in these two sectors that only partially met their targets, however, had their bond spreads widened.
This effect, however, was not observed among companies in low-emission sectors.
The study found that financial institutions that were on track in meeting their climate targets also faced higher borrowing costs over the three-year and five-year horizons.
The same goes for those that were partially on track, reflecting “investor discomfort with incomplete commitments in this sector”.
“These results suggest that in low-emissions sectors, companies meeting their decarbonisation targets may be penalised with higher financing costs, possibly due to indirect risks, perceived transition costs outweighing benefits,” said the report.
The report also noted that investors appear to differentiate sharply between issuers that are fully on track and those that are partially on-track, especially in high-emissions sectors where being on track is most material.
However, full alignment among companies in low-emissions sectors such as financial institutions may not yet earn market reward, hence highlighting the importance of execution credibility and sector-specific transition narratives.
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