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Valuations of ESG Assets May be Stretched, BIS Warns

Central banking body recommends close monitoring of further ESG market developments to manage financial risks.

The Bank for International Settlements (BIS) has warned in its quarterly review that there are signs that ESG asset valuations may be stretched.

“Demand for investment products classified as delivering ESG benefits is booming,” the BIS said, citing one estimate that measures ESG assets at US$35 trillion, which is more than a third of total professionally managed assets.

“Given the very fast growth of the new asset class, there are questions about the possibility that a bubble might develop unless market transparency can be ensured.”

The BIS compares the current ESG boom to railroad stocks in the mid-1800s, internet stocks during the dotcom bubble, and mortgage-backed securities during the GFC.

“Assets related to fundamental economic and social changes tend to undergo large price corrections after an initial investment boom,” it says.

“It is thus noteworthy that the pre-GFC growth and size of the private label MBS market are comparable with those recently observed for ESG mutual funds and ETFs.”

The BIS says there are signs that ESG asset valuations may be “stretched”, but that more analysis is needed, such as to assess valuations in credit markets or the premium investors are willing to pay for investments that support environmental or social causes.

The BIS says it is worth closely monitoring developments in the ESG market, and to potentially further assess and manage the financial risks that might arise from a shift in investors’ portfolios.

This would involve the collection of adequate data on holders and exposures, with special attention to those that are leveraged and may reside in the less transparent segments of the financial system, the BIS says.

“In turn, all this puts a premium on adequate disclosure and reporting arrangements, including more reliable taxonomies.”

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