ESG Backlash in the U.S. Fixed Income Market

2023 has seen a sharp rise of ESG pushback in the United States, sparking hesitancy in companies’ approaches to sustainability topics at a time when climate action is increasingly urgent.

What’s Happened?

ESG has become a broadly politicized topic in the U.S.

• 17 states passed anti-ESG legislation, and 6 states have announced pro-ESG positions
• At least 165 bills and resolutions against ESG investment were introduced across 37 states in H1’23 ⁽¹⁾

What is Pro & Anti-ESG Legislation? ⁽²⁾

• Divestment Law: Legislation that requires divestment from certain industries (i.e., fossil fuels).
• Pro-ESG: Encourages ESG investing and disclosure of climate-related risks.
• Anti-ESG Law: Legislation that prohibits fund managers from considering ESG factors in their investments.
• Boycott Law: Legislation that prohibits states from contracting with or investing in companies that boycott certain industries or jurisdictions.

What is the impact on the U.S. Fixed Income Market?

U.S. Corporate ⁽³⁾ issuance of ESG bonds, referring to green, social, sustainability, and sustainability-linked bonds, is down 30% YoY.

Meanwhile, USD Investment Grade ESG fixed income fund flows have increased 5% YoY in a sign of resilient investor demand.

TD’s Take: The impact of ESG backlash is corporate-led, not capital-led.

U.S. Corporate ESG Issuance by State of Domicile ⁽²⁾

Key Takeaways

Both anti-ESG and pro-ESG states are feeling the effect:

• 2023 supply from both anti- and pro-ESG states is lower than historical levels ⁽⁴⁾

Supply is becoming more concentrated among fewer states:

• In 2023 YTD, U.S. Corporates brought $30.5B in sustainable bond issuance across 19 states compared to 2022 which saw $52.3B from 26 states

While state officials have not broadly made explicit statements preventing companies from issuing in labeled format, ESG has undoubtedly become politically contentious:

• Of the 17 states with anti-ESG legislation, only 3 states have seen corporate ESG issuance in 2023

U.S. ESG Issuance by Sector ^(5,6)

• Energy-intensive sectors (including Utilities, Chemicals, Industrials, Energy, and Materials) have accounted for 44% of U.S ESG bond supply in 2023 (vs 46% in 2022), indicating stickiness from such issuers
• Despite facing intense ESG scrutiny, financial institutions have remained committed to the market, representing 15% of the market YTD

U.S. ESG Repeat vs Inaugural Issuers ⁽⁵⁾

• 2023 YTD issuance has seen the lowest participation from inaugural borrowers (33%) since the market’s inception
• Heightened scrutiny from both anti- and pro-ESG sides, including the market’s focus on greenwashing and credibility, has shifted supply towards borrowers with preestablished ESG financing frameworks

USD Fixed Income Fund ESG Flows ⁽⁷⁾

• Against the backdrop of ESG pushback, USD ESG fund flows have remained relatively resilient:
  • In 2023 YTD, both Investment Grade (IG) and High Yield (HY) ESG nominal fund flows have outperformed the prior year.
• While HY ESG funds have seen continued net outflows in 2023, the outflows have improved compared to the prior year despite the headwinds.
• Noise around ‘ESG outflows’ is largely attributable to the equity market where ESG equity funds have seen a greater impact on capital flows.
• With respect to ESG fund labeling, the market is undoubtedly going through a cleanup exercise; however, capital providers remain steadfast to incorporating environmental and social risks into investment processes.

Demand for ESG assets, as observed through fund flows, has not experienced the same level of pullback as ESG issuance, reinforcing the view that ESG backlash is having a greater impact on corporates than capital.

Navigating the Future Landscape

A Bumpy Road Ahead

In 2023, U.S. companies have faced an unprecedented level of ESG backlash from both anti- and pro-ESG sides which has had a paralyzing effect across organizations. With the upcoming U.S. elections in November 2024, ESG backlash is only expected to increase. Credibility and transparency will be key to successful market appearances.

Companies in neutral or pro-ESG states, or those financing activities with bipartisan support (ex., carbon capture), are likely to face smoother road to market than those in anti-ESG states.

Investors Will Be in the Driver’s Seat

Meanwhile, ESG-focused investors have remained relatively resilient and are eager to deploy growing pools of capital towards credible ESG fixed income investments.

Please note all volumes are in United States Dollar.

1. S&P Global Market Intelligence
2. Source: Bloomberg New Energy Finance, State Legislature
3. U.S. Corporates includes Investment Grade (IG) and High Yield (HY) U.S.-domiciled corporates and financial institutions
4. Historical average annual issuance reflects ESG issuance across 2018 – 2023
5. Source: Bloomberg; IG and HY Corporate and Financial sustainable bond new issuance volumes as of 10/31/2023
6. Industrials includes: Aerospace & Defense, Electrical & Machinery Manufacturing, Railroad, Transportation, Waste & Environmental Services
7. Emerging Portfolio Fund Research (EPFR) as of 9/30/2023 – reflects the fund flows to Corporate and Financial USD fixed income ESG funds