ESG in CDS indices

13 minute read

CDS indices are crucial for managing credit portfolio risk. How should Environmental, Social, and Governance (ESG) tilted CDS indices be used in this context? We draw some conclusions from our own trading patterns.

Market views are at odds with our views on credit derivatives and the implementation of credit derivatives in an ESG context. An explanation of the fundamental motivations for using CDS in general is required, and with regards to ESG investing in particular.

Given a particular trading mandate, we have found that where CDS played an important role, it allowed for much higher exposure to, for example, green bonds than would otherwise have been possible. The demand and supply of CDS affects cost of funding/capital for underlying issuers, and hence has a financial impact.

CDS indices can be a natural hedging product for lowering the market exposure on credit portfolios. ESG CDS indexes can be a very useful tool to manage flows in an ESG focused fund, making it possible to retain a sought ESG mix while also managing their trading in an illiquid cash market in a good way. It could also be an attractive alpha product for market timing and/or to trade the ESG factor directly.