Despite the motivations for engagement laid out earlier in this report, there remains significant inertia among fixed income investors to engage.
Below, we highlight some of the commonly heard arguments against engagement and suggest responses to overcome scepticism or reluctance to engage.
“Bondholders don’t have the legal right to engage”
Bondholders do not have the same legal rights as shareholders, as they enjoy a more secure position within a company’s capital structure. They do not have voting rights, neither do they have the formal communication process associated with attending AGMs. The law traditionally assigns greater corporate governance rights to shareholders, compared to creditors. Nevertheless, as lenders of capital, fixed income investors are perfectly within their rights to engage with companies if they feel the need to manage their investment risks. They also have the right to negotiate terms of bond covenants, and a number of investors interviewed for this report do so. Unlike shareholders, whose influence over companies is ongoing, fixed income investors have most influence with regards to primary issuance, and less in secondary markets – so they stand to maximise their engagement efforts by engaging at particular points of the issuance cycle.
“Bondholders shouldn’t engage because of their privileged position in the capital structure”
Ultimately, despite perceived conflicts between shareholders and bondholders in the short run, shareholders and bondholder interests should be aligned over longer timelines regarding the financial sustainability of any issuer.
“Bondholders don’t have the influence to engage”
When the shareholder-primacy model of corporate governance originated in the 1930s, the equity markets far outweighed the corporate bond market. However, bonds have now become the principal source of external financing for US firms, dwarfing equity issuance. Since 2006, new corporate bond issuances have exceeded new issuances of equity more than eight-fold. This increase is also seen in the number of companies that use primary bond markets, rising from about 1,250 before the 2007 debt crisis to over 2,500 today. Given the increased significance of the bond market today, fixed income investors have a strong argument for public companies to pay attention to their concerns. Doing so will help companies maintain a loyal base of creditors to provide cost-effective debt capital.
“There is no time to engage between an issuer announcing and closing a debt issue”
In a public placement, the opportunity to influence specific contractual obligations is limited, as engagement usually happens later in the issuance process. However, it is possible for investors to express their views on ESG issues, and how they may influence the decision to invest, and/or the price they are prepared to pay. This may eventually impact the prevalence of ESG risk factors required to be included in any prospectus with regard to the issuance. Post-issuance, bondholders retain some potential influence with issuers, especially where the issuer is seeking to renegotiate contractual obligations, refinance, or where bondholders attain the required quorum to convene a bondholder meeting. Furthermore, for carefully prioritised engagement targets, there will be other opportunities to engage with issuers at conferences, investor calls, roadshows, and in-person management meetings. When done well, collaboration with shareholders and/or other bondholders can be an effective way to gain corporate managers’ attention, as well as to pool knowledge, information and engagement costs.
“We do not get access to the right people at target companies as bondholders”
Some bondholders report they have limited access to senior management, particularly in comparison to shareholders, or find that the individuals who usually participate are not necessarily best placed to discuss strategic matters. For example, BlueBay Asset Management explained that, where it has sought to raise ESG matters on an ad-hoc basis with companies, it is not unusual to be faced with management representatives who were not expecting (or able) to talk about ESG issues. For instance, whereas shareholders usually meet the CEO, CFO or Chairman and the agenda can shift between a more strategic discussion on matters such as ESG and details on the financials, debt meetings are often quite technical, and focused on debt aspects, while company representatives are more likely to be the Treasurer or CFO, who are less able to effectively discuss bigger picture matters. As such, making a clear investment case for the consideration of ESG issues in credit analysis, collaboration with other investors, understanding how the company works (i.e. who does what), and communication skills to get hold of the right person are all important determinants of successful engagement.
“With more money shifting into passive funds, engagement is on the decline anyway”
In recent years, passive management has risen in popularity as investors seek to reduce investment costs. Some have expressed concerns that issuers could therefore face less scrutiny from their investors, given the rising proportion of debt held in passive funds, and the costs associated with engagement. In addition, passive investors have less incentive to engage, because there’s less flexibility to adjust weightings of investment following engagement. Many argue that passive investors’ limited scope for choosing (and avoiding) specific issuers actually increases the need for active engagement. Major passive investors such as BlackRock, Vanguard and State Street Global Advisors have increased their corporate governance resources over the past three years. State Street Global Advisors, for example, revised its corporate governance practices in 2013 in recognition of the increased importance of engaging with the companies in which it invests. This included expanding its stewardship team and engaging with companies more regularly. In 2017, the firm also developed a dedicated fixed income stewardship programme.
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ESG Engagement for Fixed Income Investors
ESG engagement for fixed income investors
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Overcoming common hurdles