Debt and equity holders both stand to benefit financially from successful engagements, as ESG-related risks are mitigated and opportunities maximised.
Engagement is common practice among shareholders as a way of discovering ESG information and influencing a company’s governance or sustainability. It is less common among fixed income investors, undoubtedly due to a lack of voting power and the position they hold in capital structures.
For longer-term or buy-and-hold style investors, engagement isn’t just about correcting faults; they should also encourage best practices via engagements. In some cases, investors may share knowledge from across their portfolio to support better management of ESG risks to help this process. Solveig Pape-Hamich, vice president at KfW, says, “firstly, we can tell them, ‘we would have liked to invest more into your bonds, but we were not able to for sustainability reasons.’” Marion Marinov, senior manager of asset allocation, adds, “the best ones get a letter as well. We tell them, ‘we really like the fact that you have good sustainability performance, but you might be overtaken next month when the others improve.’”
- To source ESG data
- To identify and measure credit risks that are otherwise difficult to evaluate
- To gain a better understanding of how an issuer is managing, or plans to manage, ESG risks
- To influence how issuers manage exposure to major risks
- To influence standard terms and content of bond documentation such as covenants
“We really see upside in companies that improve on ESG criteria. It’s very interesting to see where positive changes are being made that are not discounted yet in the value or the spread of a company.”
Edith Siermann, Robeco
Key considerations for investors on engagement
- Most bondholder engagements happen in conjunction with in-house equity teams, but bondholder-only engagement directed to different personnel may add to investor influence.
- Bondholders can use the PRI Clearinghouse Platform as a way of collaborating with others to increase their collective influence.
- Engagement should be considered an essential risk management tool by passive investors due to the lack of options to screen for or integrate ESG.
- Build strong relationships with issuers by being consistent on engagement approaches.
- Focus resources on high-risk sectors and larger holdings.
- Engage both leaders and laggards to raise minimum standards across sectors.
- Set clear goals for engagement outcomes, and monitor progress throughout the process.
- Support relevant engagement (or stewardship) codes or directives.
- Consider whether engagement becomes part of normal investment decision making and monitoring or a distinct activity with its own framework and objectives.
- Report on engagement activities and outcomes directly to clients and beneficiaries.
- Green bond road shows and investments provide opportunities for investors to engage on environmental concerns and align issuer activities with investor values.
What makes engagements successful?
Engagement is a long game; fixed income investors will build credibility with issuers by being consistent in their engagements and monitoring their progress over time. Successful engagements will typically last at least one year.
The effectiveness of engagements will depend on the strength of the relationship between the issuer and investor. This, in turn, depends on originators, whether the investor purchased the bond directly from the issuer or another investor, and the proportion of a bond that the investor holds. Other variables include current market demand, issuer credit quality and region.
Overloading issuers with enquiries about ESG may be counterproductive. Ensure that questionnaires are succinct, and source data from ESG research providers where possible.
Practicalities of engaging issuers on ESG issues
Who should conduct engagements?
Depending on whether the engagement is conducted to gather ESG information or to influence issuer behaviour:
- Fixed income analysts
- ESG analysts
- Portfolio managers
- Internal engagement specialists
- External service providers
Collaboration helps investors increase their influence and avoid duplication of efforts when trying to manage ESG-related issues. Groups of investors can share important feedback from these engagements in order to improve their understanding of ESG-related risks. Aside from engaging companies and local government issuers, investors may also engage more broadly with regulators, banks, credit rating agencies and other stakeholders.
- The PRI coordinates engagements on priority topics, and the PRI Collaboration Platform allows signatories to post engagement topics that others can join.
How to prioritise engagements and engagement resources
Engagement can be resource intensive, so it is important for investors to prioritise engagements based on:
- relative ticket sizes in an individual bond or total volume of holdings;
- the severity and materiality of the ESG-related risks involved;
- ESG concerns where investors expect to have the most impact.
Who to engage?
Engagements can be addressed to senior management staff such as chief financial officers, legal, investor relations, health and safety and corporate responsibility staff.
“Meetings with corporate issuers also tend to be a good source of information for the sovereign analysis. If they don’t have an answer on ESG risks, that’s also very telling.”
Gorky Urquieta, Neuberger Berman
Engagements vary considerably depending on the scale of the investor, the engagement opportunity and the issuer’s willingness to meet with investors. PRI signatories have stated that they engage government officials, including senior management from treasury departments and government agencies (e.g., the US Environmental Protection Agency), debt management offices and export credit agencies. (There is a fine line between engaging and lobbying government officials or influencing public policy. Some investors consider engagement with government issuers as either impossible or inappropriate.)
“Namibia is a relativ%ely well-rated country, but about 82% of its electricity comes from high-polluting power stations in Zimbabwe. Our portfolio management team met with their grid operator, Nam Power. Those are the people we need to talk to and say: Are you open to green energy?”
Michael Schneider, Deutsche Asset & Wealth Management
How and when to engage?
Although the window for engaging issuers upstream is often small, it is also the time when bondholders can have the greatest influence. Investors can engage pre-issue during fundraising road shows and corporate book builds. PRI signatories typically engage via phone calls, emails, letters, and in person at conferences and during investor roundtables.
Post-investment, the relationship between bondholder and issuer becomes a contractual one and ESG considerations are unlikely to be a part of that contact. However, investors do retain some influence as potential future investors depending on their size. They should therefore consider engaging at quarterly meetings, in response to financial reporting, in conjunction with shareholder meetings and during country visits (with corporates and governments).
Asset owner considerations
- Engage issuers to protect against financial downside of ESG factors including external audit process, transparency, risk management, etc.
- Engage issuers to mitigate reputational risks or manage ethical concerns.
- Engage alongside investment managers to increase influence.
- Join asset owner coalitions to collaboratively engage issuers or sectors.
- Encourage collaborative engagement by multiple fixed income managers.
- Include engagement outcomes in manager monitoring.
- Encourage information sharing and collaboration between equity and fixed income managers for greater influence.
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