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Silence is not golden: bond investors try to find their voices

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Many bond investors now say they engage with borrowers on ESG issues. Companies are noticing, and a virtuous circle is beginning to turn. But much of the conversation is still very gentle and diffuse, and not concentrated at the point of capital raising. As Jon Hay reports, more ambitious engagements to change whole industries lie in the future.

When assessing the progress of environmental, social and governance investing, there are often two apparently contradictory levels. Investors that have signed the Principles for Responsible Investing now manage $80tr of assets — more than enough to have saved the world, one might think. Yet the same dirty old economy throbs on.

This disconnect pops up in subsectors of responsible investing. Engagement — which means speaking to organisations you invest in about their ESG performance — is the second PRI Principle. All signatories are committed to doing it.

But bond issuers and buyers say ESG issues hardly crop up in the dialogue when capital is raised. From one perspective there has been great progress — from another, little.

Engagement is important for many reasons. Investors can sell the bonds of companies or governments that are ESG villains, or buy them more reluctantly. But that is like whispering behind someone’s back.

Successful borrowers have hundreds of investors, and won’t notice one or two slipping away. Weak borrowers have bigger problems. If their spreads widen, they will put it down to credit difficulties. The market signals will reach the borrower only slowly and indistinctly.

“Excluding an issuer probably isn’t the most effective way of trying to achieve change,” says Maxime Molenaar, a responsible investment officer at Actiam, the Dutch asset manager. “It’s a last resort. It makes more sense to try to influence the company beforehand.”

As in every walk of life, making a fuss works — or at least, has a better chance than accepting things meekly. 

Especially if the complainer is prepared to back up words with action. “From our sales feedback we are starting to see that institutional investors, for example Dutch pension funds or big insurance companies, sometimes don’t want to invest in corporate bonds anymore if the ESG rating is too low,” says Xiaofei Guo, a banker in ING’s sustainable markets team in Amsterdam.

Investors who tell an issuer about their concerns may find it smartens up its act. 

“Selfishly, dollars and cents-wise, the pace of environmental change is up, the pace of social change is up, the risks are a lot higher over the medium and long term for a lot of credits we invest in,” says Scott Mather, CIO of core US strategies at Pimco in Newport Beach. That means from a risk-reward perspective, Pimco believes engaging is “pretty obvious”.

Both parties can win from the interaction. The issuer learns something about what its investors care about. And if it makes ESG improvements astutely, it could boost its value in the eyes of the investor, and perhaps in absolute terms. 

Crossing over

Traditionally, engagement was the preserve of equity investors. Shareholders’ voting and ownership rights give them an explicit say in how companies are run, even if most just tamely follow management’s lead.

Seasoned bond investors used to doubt whether they even had a right to question companies they invested in. Making demands of governments still sits ill with most bond investors.

But norms have begun to shift. “Three or four years ago, nine out of 10 treasury departments would not have been involved in sustainability presentations about the company,” says Othmar ter Waarbeek, head of corporate bond origination at Rabobank in Utrecht. “They weren’t even aware sustainability ratings existed. That has now completely changed and most treasuries have embraced sustainability. I’ve certainly attended roadshows where these questions are being answered very specifically. Ninety-five percent of issuers are outside the danger zone, at least for now, but it is waking them up to start incorporating ESG as part of their treasury policy.”

Two of the biggest European corporate bond issuers, German car companies, confirmed to GlobalCapital recently that for the first time, they were now getting ESG questions on normal bond roadshows.

SRI Report

“There is tremendous untapped potential for fixed income investors to encourage issuers to correctly scope out the risk and opportunities they face,” says Mather.

Yet market participants still tend to see ESG in bond markets as being about green bonds. 

In financial institution roadshows for ordinary bonds “it’s not that often ESG comes up,” says Jasper van Balen, head of financial institutions origination at Rabobank. “It’s not on the top of mind of most investors to challenge the travelling team on their sustainability. However, within the scope of green bonds, you can clearly see bondholders becoming more vocal in saying what they are looking for.”

Themed financings seem to give bond investors a licence to talk. They often get very detailed about what they like and don’t like about a green or social bond framework.

“The big discussion is impact,” says Crispijn Kooijmans, head of public sector origination at Rabobank. “It’s hard, even harder for social bonds, but that’s the key topic. The asset managers, fund managers, pension funds want data they can show to their stakeholders.”

But if investors are content to engage only on green and social bonds, it will have limited effect. They are a tiny share of the debt market, and come from issuers who already think about sustainability. 

Also, the issuer chooses the ground on which the engagement takes place. The green bond proceeds are directed to a certain portion of its business. But investors gain no special insight into the rest of its activities.

Green bond investors increasingly consider an issuer’s overall ESG performance, as well as just the earmarked assets. But they could apply that approach also to issuers not issuing green bonds.

Little by little, some degree of engagement by bondholders is becoming normal. 

Sergey Dergachev, head of emerging market corporate debt at Union Investment in Frankfurt, says it remains a “very nascent topic” in EM debt, though ESG has been gaining traction rapidly in the last three years. But Union is enthusiastic. “We meet with management, we talk about ESG and if there are some issues which we feel can lead to financial or reputational risk, we address it to management,” says Dergachev.

The question then becomes: are bondholders engaging in the most effective way — and are they being as forthright as they might?

The PRI’s guidebook on bondholder engagement, published in April, recommends a highly organised approach in which the investor has specific goals, concentrates on carefully chosen names in the portfolio, and joins forces with other investors where possible.

Actiam is right on the money here. It focuses on three issues: climate, water and land. The ESG team develops engagement ideas. When companies violate Actiam’s goals, its engagement committee, which includes the CEO, can start a ‘responsive engagement’. If the company doesn’t make enough progress, it can be excluded from all portfolios. Volkswagen was dropped after its emissions cheating scandal, when Actiam felt it was not dealing with the issues fast enough. 

But many investors engage in a more informal, unstructured way, using their opportunities to meet companies as best they can, and saying as much as they dare.

Two prongs may be better

Big fund managers now have engagement specialists, usually in the ESG team. They often engage with issuers as holders of both equity and debt. As Molenaar says: “We are not making any distinctions between whether we have exposure on the equity or bond side — the issues we address are the same either way.”

However, this unified approach could blunt the edge of bondholder engagement. If an investor’s ESG analysts meet a company’s head of corporate social responsibility, they are likely to get time to say a lot. The message will be relayed to management at some stage.

But not all corporate boards listen to their heads of CSR very much. Engaging directly with the CEO, CFO or treasurer may have more bite. And that is likely to require the equity and debt investment specialists to do it separately, at the point when the company is asking for their money.

Bond investors are by no means the poor relations here. “There’s something unique about the fixed income market that means investors do have opportunities for influence,” says Mather. “Big issuers need to keep coming back to market.”

Roadshows for bond issues involve one-on-one meetings with big investors such as Pimco and group meetings or calls for the rest. The latter may give the investor maximal clout. If a senior executive is asked a question about ESG in front of a room full of investors and cannot give a satisfactory answer, the result is magnified. More investors may be unimpressed — and the company will have a keen incentive to make good. So far, it is hard to find market participants who say that investors ever use this power.

Dergachev says Union does use conference calls for engagement sometimes — but ESG issues are rarely mentioned on EM bond roadshows. Union is careful to take into account the mentality and culture of the issuer, partly because it, too, wants a long term relationship.

Seeking ambition

Another kind of action that remains marginal in bond markets is concerted engagement campaigns, where investors go on the offensive to pressure companies to change.

Since 2014, Boston Common Asset Management has been leading a group of shareholders that has grown to 100, with $2tr of assets, calling on banks to examine the risks they face from climate change and seek opportunities to ameliorate it. The world’s top 60 banks are targeted, and over 80% now engage with the investors. Banks are publicly scored and ranked. The investors’ latest report found “some progress” but also “urgent shortcomings”.

SRI Report

Why does this kind of work not exist in the bond market? Wolfgang Kuhn plans to find out with a pilot project for ShareAction, the responsible investing NGO. Kuhn, former head of European fixed income at Aberdeen Asset Management, wants to interview two dozen asset owners and bond managers, to find out how far they would go in action on climate change. 

His model is Climate Action 100+, a huge shareholder engagement launched in December 2017 that now has $29tr of backing. It is directed at 100 companies that are among the world’s biggest greenhouse gas emitters.

Halfway through the project, Kuhn says: “It’s not going to be easy to activate bondholders. I see a lot of hesitation towards pushing companies very hard. Some investors have very strong views and are happy to express them, but there is a hesitation to tell management what to do, which I find surprising, because it is your money.”

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