Environmental Finance spoke with the Asian Infrastructure Investment Bank's (AIIB) Director General Dong-Ik Lee, about the bank's Sustainable Capital Markets Initiative (SCMI) and its approach to environmental, social and governance (ESG) integration and engagement.

Environmental Finance: Can you outline the ambitions of AIIB's Sustainable Capital Markets Initiative (SCMI)?

Dong-Ik Lee: The SCMI seeks to address the historical misallocation of capital resulting from the failure to properly internalise environmental and social costs as well as the benefits and impact of a strong ESG focus.

Launched in 2019, we have developed an ESG Framework and Climate Change Investment Framework – and invested in our Asia ESG Enhanced Credit Managed Portfolio and Asia Climate Bond Portfolio – to catalyse sustainable investing strategies. The SCMI also includes research, knowledge sharing, and industry engagement, as well as efforts to develop ESG standards and build capacity for making sustainable investment decisions supported by improved disclosure and expanded ESG rating coverage in emerging Asia.

EF: How has your Asia ESG Enhanced Credit Managed Portfolio performed?

DL: The portfolio's performance, both in terms of returns and sustainability indicators, has been positive. This project seeks to entrench ESG principles into Asia's corporate bond market, which is critical to helping fund the region's infrastructure development. The two major approaches to achieve impacts are ESG integration and ESG engagement with issuers.

EF: How receptive are Asian corporates to ESG concepts?

DL: Asia's corporates are less familiar with ESG concepts. However, we have been surprised to see a good number of issuers showing meaningful engagement and embracing our ESG approach. Our engagement is adaptive and includes a broad range of ESG-related topics. For example, since the emergence of Covid-19, we see the importance for companies to implement measures to ensure employee and customer health and safety. Our asset manager, Aberdeen Standard Investments, evaluates the impact of such measures on a company's profitability and sustainability during their due diligence process. Our engagement has been used as a mechanism to influence and advise the future policies of these companies.

EF: Do you have an example of your engagement work?

DL: We engaged with a Russian steel producer that naturally is exposed to environmental and health and safety issues. As a result of our discussions, the management team committed not to develop any coal production capacity, took steps to improve board oversight of ESG matters, and will be adopting the Investor Mining and Tailings Safety Initiative.

EF: What can you tell me about emerging market infrastructure as an asset class and how AIIB is addressing the infrastructure financing gap in Asia?

DL: Private capital sources, especially institutional investors with long-term liabilities, are a key part of addressing the infrastructure financing gap in Asia. As a multilateral development bank with a mission to finance Infrastructure for Tomorrow, AIIB seeks to develop emerging market infrastructure as an asset class to catalyse private sector capital.

AIIB has invested in a new platform business – Bayfront Infrastructure Management – that purchases predominantly infrastructure loans from financial institutions and distributes them to institutional investors through the creation of infrastructure asset-backed securities (IABS). IABS allow investors to invest in rated and listed debt securities backed by a diversified portfolio of project and infrastructure debt. With Bayfront serving as a reliable off-taker of infrastructure debt, this also incentivises financial institutions to redeploy freed-up capital to new projects.

In June 2021, Bayfront debuted the first issuance of IABS, including a sustainability tranche. The issuance will offer investors access to a $401 million portfolio of 27 loans, diversified across 13 countries and eight industry subsectors. AIIB committed $60 million as an anchor investor, which will set an important market benchmark.

EF: How have you identified the appropriate metrics to track in your AIIB-Amundi Climate Change Investment Framework?

DL: The AIIB-Amundi Climate Change Investment Framework's approach translates the key objectives of the Paris Agreement into metrics to assess an issuer's alignment with climate change mitigation, adaptation, and low-carbon transition objectives. Each objective can be translated into investment risks and opportunities with the potential to impact portfolio-level returns. The framework is a knowledge product from AIIB's Asia Climate Bond Portfolio, whose objective is to invest in climate champions that will outperform in the long run.

We expect portfolios aligned with this framework to benefit from any future repricing of climate change. Through the framework, we also encourage targeted engagement with issuers to integrate climate risks and opportunities into business practices and to improve disclosure and data availability aligned with reporting standards such as the Task Force on Climate-related Financial Disclosures.

EF: What data availability challenges do you face?

DL: It is important to focus on enhancing ESG data availability. We have recently seen ESG rating agencies expanding their coverage, which creates a virtuous cycle – more issuers develop, disclose, and honour their ESG policies, while bond investors increasingly use ESG ratings to supplement traditional credit analysis. In our Asia ESG Enhanced Credit Managed Portfolio, we are targeting a 90 to 100% external ESG rating coverage and we have seen a gradual improvement in the ESG scores of our holdings. Ultimately, we hope to help create an investor-friendly environment, which is encouraging and rewarding to ESG-minded investors.

EF: What are your plans for the SCMI going forward?

DL: We will continue to implement our ESG approach under the SCMI to further promote tools and market dynamics that support sustainable decision-making by investors and issuers, while also leveraging our own investment portfolios to build evidence-based proofs of concept to generate data, build investor confidence, and add momentum to the development of sustainable capital markets.