It's time for bondholders to take their seat at the stewardship table

Debt is just as important as equity funding, if not more, accounting for nearly 90% of all capital raised by non-financial companies in UK markets over the past decade. This funding role charts a path for bondholders to engage, linking the setting of expectations and concerns to the decision to provide funding. However, while bondholders are starting to engage more, there is a long way to go before this is consistently and effectively put into practice. 

In June 2023, nearly 100 professionals across the investment chain gathered at the University of Oxford for an industry-first symposium on bondholder stewardship and its role in driving positive sustainability outcomes. Co-hosted by the Oxford Sustainable Finance Group and ShareAction, this year’s symposium capitalised on the momentum of corporate transition planning, a very hot topic among investors and regulators ahead of the release of Transition Plan Taskforce’s highly anticipated final disclosure framework and guidance published on the 9^th October 2023. 

Implementing transition plans will require massive investments from corporates to align themselves with a Net-Zero emissions pathway. It is likely that a material portion of this finance will come from debt capital markets, so bond investors should naturally have a say in how their money is being used to fund a company’s transition. Moreover, the transition will usher in a significantly different economic landscape and companies’ ability to adapt will have strong implications for their long-term credit-risk profile. 

Titled The power of debt investors: how can engagement through fixed income drive positive sustainability outcomes?, the symposium brought together a broad array of actors across the fixed income ecosystem, from practitioner investors to academics, regulators and NGOs, to have a frank discussion about the challenges and opportunities for effective and collaborative stewardship. Panellists included regulators such as the Financial Conduct Authority and Financial Reporting Council, asset managers and owners including Legal & General Investment Management, Insight Investment, RBC BlueBay, Brunel Pension Partnership, and Railpen, as well as senior colleagues from Slaughter and May, Standard Chartered, MSCI, Transition Pathway Initiative Centre, and the Anthropocene Fixed Income Institute. 

This was followed by four case studies on some of Europe’s largest companies and their transition plans, where participants applied learnings from the morning panels to develop a practical model of stewardship. Here, we summarise the five key insights that emerged from the rich discussions in panel sessions and case studies.

1. There is no shortage of opportunities for effective bondholder stewardship

   Bondholder stewardship is at an early stage, but there has never been a better time to engage on environmental and social issues. 
   
   Firstly, issuers are more literate on the financial and credit-profile implications of the net-zero transition than ever before. Secondly, the current market backdrop of increasing interest rates has tipped the scales in favour of bondholder stewardship, supporting their engagement with, and setting expectations of, borrowers. Years of low interest rates created an imbalance between the demand and supply of debt, resulting in the trend of covenant-lite bonds, where investor rights, responsibilities, and protections were minimised. Rising credit spreads and higher interest rates have provided bondholders with more power to negotiate stronger contractual protections, including on sustainability factors. One panellist pointed out that bondholders can do this by pushing for stronger rights and sustainability-related restrictions in bond contracts, which parties are free to negotiate. In their words, there is nothing stopping bondholders from asking for an annual general meeting or introducing positive covenants for more ESG-disclosures. Thirdly, because companies frequently access debt capital markets to raise new or refinance maturing debts, bondholders are afforded multiple contact points to engage issuers throughout the debt cycle. Speakers agreed that pre-issuance is the point of maximum leverage of influence for bondholders. 

2. Bondholders can amplify their impact with equity colleagues

   Traditionally, stewardship teams have largely engaged through an equity lens where they can leverage voting rights and more direct access to a company’s board and senior management. However, a common theme from the panellists was that sustainability goals between credit and equity teams typically overlap, so capturing credit interests alongside those of equity colleagues in stewardship may not only amplify each other’s voice, but also deepen analysis that strengthens the credibility of an investor’s advocacy. Debtholders can and should also leverage existing engagement channels such as dialogue with an investor relations team, a company’s treasury, and the CFO, providing additional pressure points and complimentary channels of influence to equity stewardship.

   Finally, there is an emerging argument that multi-asset managers could deny debt and engage on equities, since each action would capitalise on each security’s strengths and address the weakness of the other (see Exit vs Voice vs Denial of (Re)Entry: Assessing Investor Impact Mechanisms on Corporate Climate Transition, Hoepner & Schneider, 2022 and Evidence-based climate impact: a financial product framework, Quigley, 2023 for examples). The threat of debt denial thus creates scope for more impactful bondholder engagement. Indeed, one panellist noted that once they declined to participate in a bond transaction, a previously reluctant US issuer became far more amenable to engagement and meeting the investor’s expectations. 

3. Engage with the bond ecosystem, not just the borrowers

   As the fixed income ecosystem is currently designed, the relationship between bondholders and issuers is heavily moderated by underwriting banks and law firms, all of which advise on deals and bond structures to meet investor demand. Regulators and index providers also have a significant influence over the design of bond markets and how investors manage their portfolios. Instead of a narrow focus on conventional channels, panellists agreed that investors should engage through these important intermediaries who can act as liaisons with issuers. Consider the role of investment banks in capital markets. Their main goal is to connect companies with investor capital – if investors make the conditions for this capital clear to syndicating banks and legal advisors, such as science-aligned transition plans, this will invariably feed through to banks who can better prepare borrowers for coming to market. 

   Additionally, speakers highlighted that debt investors have significant leverage to engage with syndicating banks on their expectations of borrowers, both because investors generate significant fees for those banks (through both primary and secondary activity) and because debt investors are often large funders of banks, as banks account for a bigger portion of debt markets than they do in equity markets. 

4. Stewardship opportunities vary within the bond market

   Though high yield issuers come more infrequently to markets than investment grade issuers, bondholders enjoy more influence at points of engagement since these companies are often more reliant on debt capital within their total funding mix. Given sustainability reporting and ESG disclosures of high yield issuers are often less advanced, stewardship must begin with acquiring data prior to strategy engagement on sustainability objectives. Further, high yield issuers will often have a single owner (a private equity house, or founding family) rather than diverse institutional shareholders, creating more pointed channels for bondholder influence. 

5. There is great potential to expand collaborative engagement between bondholders

   Numerous studies have shown that collaborative efforts between investors greatly increase engagement success, particularly on environmental and social issues. Initiatives such as the UN Principles for Responsible Investments and Climate Action 100+ provide strong platforms for collaborative engagement. However, these circles remain largely dominated by equity investors. Speakers and participants noted that opportunities for collaboration in fixed income are far and few between and thus a low-hanging fruit to advance the practice of bondholder stewardship. 

   While investors sometimes place anti-trust concerns as constraints on their ability to collaborate, speakers noted these are largely overdone as collaboration to tackle sustainability issues do not carry material anti-competitive risk, nor is it the intention of regulators to prevent co-ordinated approaches to solving complex systemic problems. Asset owners also have a role to play by scrutinising asset managers on how their engagement policy and strategy is defined and measured, and should also work together to narrow down stewardship objectives and design products that deliver on investment objectives. The IIGCC is in the process of launching their Bondholder Stewardship Hub, which is expected to build on their excellent guidance released just days prior to the symposium.

The opportunities for bondholder stewardship abound. The symposium laid the foundations for a community of practice for bondholder stewardship, with broad attendance from actors across the ecosystem demonstrating their appetite for success. The Oxford Sustainable Finance Group and ShareAction believe that we are seeing the beginnings of greater bondholder engagement throughout the investment chain, from top-down regulatory coverage to bottom-up bond structuring. Market conditions are also suitable for bondholder stewardship, with asset managers in a favourable position to engage with issuers on environmental and social issues. Indeed, case study participants consistently found that while the net-zero transition is clearly credit material, the granularity of companies’ transition efforts were inadequate, funding of capital expenditure insufficiently robust, and plans generally failed to align with a science-aligned pathway, all of which invites better bondholder stewardship. 

We hope to build on the momentum created by the symposium to develop a community of practice around bondholder stewardship, in order to ensure that intention fully delivers on its potential. And with some industry developments already underway, it now seems that it is no longer a question of if, but when engagement by bondholders on sustainability becomes a well-established aspect of investor stewardship.