Legal ignorance chills bondholder engagement

Bondholders are still afraid to form alliances like those in the equity market to pressure issuers to improve their environmental, social and governance performance. They are paralysed by fear of market abuse and competition rules. But there is hope regulators will reassure them.

  • By Jon Hay
  • 18 Jul 2019
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In responsible investing, one of the principal tools is engagement — investors talking to issuers to ask for more information about their ESG attributes, requesting them to improve, and sometimes threatening to cut or exit their investments.

Increasingly, shareholders are engaging collectively to try and force change. The biggest such effort is Climate Action 100+, a drive launched in December 2017 to press the world’s 160 biggest carbon emitting companies to set science-based targets to reduce their carbon emissions to safe levels. The group includes 320 investors with $33tr of assets under management.

But there is nothing like this in the bond market. Even though nearly all the large investors in these coalitions buy bonds as well as equities, and most investment firms now engage one-on-one with issuers for both their bond and equity holdings, they have not made the leap to doing collaborative engagement on bond investments.

Five months ago, ShareAction, the UK NGO that promotes active responsible investment, published a report into the prospects for collective engagement to begin in the bond market.

Entitled Sleeping Giants: Are bond investors ready to act on climate change?, the report found that, essentially, nothing was happening.

The study, by Wolfgang Kuhn, the former head of pan-European fixed income at Aberdeen Asset Management, was reported in detail by GlobalCapital.

No progress yet

On Thursday this week, ShareAction held a meeting at the offices of the National Employment Savings Trust, a UK government-backed pension fund, to present the report and try to stimulate interest in building an active bondholder engagement movement.

Some 40 people attended, including representatives of asset owners, asset managers, regulators and civil society organisations. The meeting was held under the Chatham House Rule, which forbids quoting speakers by name.

It was clear that neither ShareAction, nor any of the other speakers at the meeting, had yet heard of any development in the market to break bondholders’ silence.

For years, most bondholders did not even consider they had the right to engage on ESG issues — even though their equity colleagues did, and they themselves engaged on purely financial matters.

That attitude has now changed. But collective engagement remains a dead space. Now that investors are at least thinking more about the possibility of ESG engagement, the obstacles barring them from collective action are becoming clearer.

“The most important barrier is legality,” said Kuhn, who agreed to let GlobalCapital quote him. “People are very worried about being seen as acting in concert, being anti-competitive or conducting market abuse, for which you can get a fine or even go to prison.”

ShareAction has four central recommendations. Regulators and public bodies should clarify what bondholders are allowed to do. Asset managers should be clear about how they conduct engagement.

Asset owners need to be clear with asset managers what they want done in terms of managing the impact of their investments on the outside world — a consideration that goes beyond just avoiding ESG risks to the portfolio. This should be included in investment management agreements, the contracts that formally set out the relationships between asset owners and asset managers.

And ShareAction called on itself to start a bondholder engagement movement.

Fear of the unknown

But the perception of legal problems is chilling activity. “The issue raised is: could a group of investors work together to refuse refinancing to an issuer?” said one engagement expert. “You would want to be very nervous about it. The chances of acting in concert or creating non-public information are very high. When a decision is that specific — threatening to withhold finance — a lot of thought would be required.”

But the threat of divestment has to be there to give a collective engagement clout. “If companies in a climate crisis still don’t think it’s necessary to have clear objectives on Scope 1, 2 and 3 [greenhouse gas emissions], constructive dialogue goes to a certain point” but tougher action may be required, said Kuhn.

The perception that bondholder engagement is legally risky is widespread. It surfaced strongly in the responses to a consultation the Financial Conduct Authority held, jointly with the Financial Reporting Council, earlier this year, on what it could do to create the right conditions for effective stewardship by investors.

“There is a fear that dialogue among bond managers, and anything that looks like organised dialogue, is a no-no — even if it’s driven by acting in the best interests of beneficiaries,” said one speaker. “That’s a real problem.”

One fear is of inadvertently creating insider information. If, during an engagement, a company tells an investor something that is material under the Market Abuse Regulation, it must immediately disclose this to the whole market. Equally, an investor runs the risk of making itself an insider if it gains material private knowledge.

All investors who do any kind of engagement are used to coping with this problem. But some appear to be worried that a threat of refusing to buy a specific bond issue could be construed as a material, market-moving fact.

A concern that more particularly affects collective engagement is that investors banding together could be seen as forming a concert party, or acting anti-competitively.

No different from equities

“It’s a fairly well known problem in the equity market,” said Simon Gleeson, a banking and financial markets partner at Clifford Chance in London, who was not at the ShareAction meeting. “The difficulty is, if you get a bunch of shareholders getting together to achieve a result, the first thing everybody thinks is ‘it might be market manipulation, and what are we going to do about it?’ There aren’t clear answers. We have from time to time gone to the regulators and said: ‘If you want investors to be active, it would be helpful if you could at least say something to the effect that investors can co-operate and speak to companies together without being accused of breaking the law.'”

But he said the regulators had responded: “Only the guilty have anything to fear, so don’t worry about it.”

Gleeson said the issues were the same for listed bonds as for equity, since the rules governing the markets were the same. “I wouldn’t say there was anything about the bond market that disapplies any of the issues that normally arise in the equity market,” he added.

He was not aware of any investors ever having got into trouble for collective engagement, or having been threatened with legal action.

The fact that collective engagement is regularly practised in the equity market proves investors can do it legally. Much of the legal groundwork for how to do this was laid by the Investor Forum, a non-profit group set up in 2012 after a government report recommended facilitating collective engagement.

“If you were to talk to the authorities about it, I expect they would say: ‘we would apply the rules in a context-sensitive fashion',” said Gleeson. “'We’re not trying to suppress legitimate activity, we’re trying to suppress market manipulation.’ The basic point is: if you believe in markets and want them to work, then this sort of thing is actually the motor for effective markets. What’s the problem? This is how market discipline is supposed to work.”

One of the main ways investors sterilise any risk that what they are doing could be manipulative is by disclosing it publicly.

The FCA recognises the perception problem. It realises that collective engagement can be an effective tool and is very supportive of the work done by the Investor Forum to work out how to navigate regulatory barriers to ensure there is an environment in which collaborative engagement can be carried out. It is working with the Investor Forum to try and support this process.

The FCA is now looking closely at whether it can provide explicit guidance to alleviate the concerns.

  • By Jon Hay
  • 18 Jul 2019

Global Green Bonds

Rank Lead Manager Amount $b No of issues Share %
  • Last updated
  • Today
1 Bank of America Merrill Lynch 13.40 57 7.41%
2 Credit Agricole CIB 10.17 61 5.62%
3 BNP Paribas 9.85 60 5.45%
4 HSBC 9.65 70 5.33%
5 JPMorgan 8.27 54 4.57%