Bondholder Stewardship: Filling the Void

Chandra Gopinathan, Chair of the Bondholder Stewardship Working Group for the Institutional Investors Group on Climate Change, explains why empowering bondholder stewardship is vital to driving the climate transition.

Companies need capital to transition their business models, assets and activities to align with net zero, with the International Energy Agency (IEA) estimating the financing required between now and 2050 for businesses to stay within 1.5°C scenarios at US$109 – US$275 trillion.

Given the US$226 trillion in outstanding global long-term corporate debt as of 2021 compared to US$94 trillion in listed equities, bondholders are vital to providing transition capital.

“Bondholders are senior but they don’t have voting rights and mechanisms,” says Chandra Gopinathan, Senior Investment Manager at Railpen, and Chair of the Bondholder Stewardship Working Group for the Institutional Investors Group on Climate Change (IIGCC).

“You are pretty much along for the ride.”

If a business is being run smoothly, bondholders will have access to the CFO and the treasurer involved in the bond issuance. But there is typically no dialogue with the CEO or the climate and sustainability officials within the company, says Gopinathan, adding that the situation is improving in this regard.

Making sure bondholders are using their capital to steward the entire lifecycle of the bond is critical, he says, requiring access to – and analysis of – the entire climate strategy of the issuer.

“Stronger bondholder stewardship is essential to improve overall governance and accountability mechanisms in the absence of legal voting rights.”

Bondholder stewardship and engagement practices are less established relative to equities and are hampered by the absence of bondholder-specific guidance, governance structures, disclosure, accountability mechanisms and escalation measures, according to the position statement by the IIGCC’s Bondholder Stewardship Working Group.

“The absence of regular voting rights has been mistakenly understood to mean the absence of bondholder influence,” the statement said. “There is therefore a clear need for an industry-wide collaborative guide for bond issuers and investors on how that influence can be used to meet investor climate objectives, focusing on best practices for climate-related disclosure, stewardship and engagement, and new financing structures.”

Stronger stewardship

Chaired by Gopinathan, the IIGCC Bondholder Stewardship Working Group represents asset owners and asset managers and is comprised of nine core members representing £2.66 trillion (US$3.2 trillion) in asset under management, including Allianz Global Investors, Eurizon Capital and Phoenix Group among others. The aim is to improve governance for bondholders, while providing practical guidance and a collaborative, structured and best practices-led approach to bondholder stewardship.

Its first workstream, Bondholder Engagement, is focused on improving stewardship and engagement practices throughout the lifecycle of the bond, to encourage high emitting issuers to develop credible transition plans. It also serves as a pilot programme to explore new bondholder engagement approaches in initiatives like Climate Action 100+ (CA100+).

Secondly, the Financing Structures and Frameworks for New Issuances workstream aims to develop best practice standards for new issuance, including labelled green bonds, for issuers and investors to support credible transition initiatives, and scale green and transition activities finance to meet net zero goals. The workstream also looks to identify methods for improving the debt financing ecosystem to align and steer the net zero transition by working with corporate issuers, banks, private equity and regulators.

“The idea is to make stewardship for bondholders stronger,” says Gopinathan, noting the working group’s focus on corporate not sovereign debt.

The working group has split up its work according to the different stages of the bond lifecycle because investors face different challenges during issuance, secondary trading and at the maturity and refinancing stage, he explains. To date, a lot of the work has been focused on the issuance process.

When a new bond is issued the window of time to gather relevant information is short, particularly if it’s a high yield bond, he says, with investors having anywhere from three days to a week-long roadshow to engage with the issuer and ask for relevant information before deciding on whether to purchase the bond.

“It’s a short window overall,” he explains. “A much longer-term approach towards the financing lifecycle is needed with guidance for how investors approach every single stage.”

The overall premise of bondholder stewardship is to capture the opportunity for partnership in the transition to net zero, he says, as bondholders typically fund anywhere from 50-80% of a company’s capital structure.

Leveraging influence

The Bondholder Engagement guidance (workstream one) focuses on the secondary bond market, with the working group’s discussions centred around best practice approaches that investors can employ when engaging with issuers.

“There are a number of asset owners and managers who are engaging with companies on a regular basis, it’s just happening in a much more fragmented way,” he says, with the guidance building on the principles laid out for listed equities, along with other industry guidance, to provide a life cycle-based net zero engagement approach to corporate debt.

“We try to tie it back to the Net Zero Investment Framework,” he says, referring to the recommended actions, metrics and methodologies issued by the IIGCC to investors in 2021. “We look to create various examples and case studies of investors who are engaging in these sorts of issuances and assess how they are assessing climate and net zero at the corporate level and how that is linked at the bond level.”

The guidance will also consider opportunities for improving collective engagement on corporate debt and establishing a common investor voice on the expectations for issuers and the wider debt financing ecosystem, from banks to second party opinion providers and ratings agencies.

The concepts and approaches identified by the working group may inform engagements with Climate Action 100+ focus companies – the recommendations will also be disclosed to regulators and policymakers.

“The idea is to help investors with escalation strategies,” he says, with bondholders feeding into equity-led engagement at AGMs.

Issuance and issuer misalignment

The Financing Structures and Frameworks for New Issuances guidance (workstream two) covers some very different territory, including green bond issuance.

There are several frameworks and existing standards for a variety of green and other labelled bonds, such as the International Capital Market Association’s (ICMA) Green Bond Principles, the Green Loan Principles developed by the Loan Market Association, as well as the work being carried out by Climate Bonds Initiative (CBI).

The IIGCC is supportive of the ongoing work by these organisations but seeks to provide complementary guidance on financing structures and frameworks to encourage more robust products and best practice templates for new issuances.

“If you speak with investors in green bonds, they will tell you that there are gaps in some of these frameworks which need clarification and standardisation between them,” Gopinathan says, adding that this is a core focus for the working group’s second workstream.

“The gaps really are between the issuance of the issuer. A lot of the frameworks, which are voluntary, operate very much at the issuance level,” he says. “You can potentially have an issuance that requires an issuer to adhere to a green project use of proceeds being segregated from the corporate issuance, but a lot of times it doesn’t necessarily link back to the issuers’ net zero commitments.

“Where there is a clear misalignment between the two that needs to be highlighted and clarity needs to be provided about how that link can be maintained.”

By developing best practices guidelines, he says, the IIGCC aims to fill in those gaps between the issuance and the issuer to empower investors to “differentiate between the good, bad and the ugly for the entire universe of sustainability linked issuances”.

“Logical progression”

Gopinathan stresses the importance of an objective, independent framework for all new sustainability-related bond issuance for accurately assessing the issuance format and structure to see how they tie together, or don’t, in terms of their alignment to net zero commitments.

“Based on that, investors will have access to a quality, objective assessment of a particular issuance, so they can make an informed decision on whether they want to buy, or not, going forward.”

 The IIGCC is looking to complete its work on the first of the two workstreams by the end of March, with the second completed by the end of June.

The deliberations of the IIGCC Bondholder Stewardship Working Group are a natural progression from the Net Zero Stewardship Toolkit that the organisation and Railpen co-authored in 2022, explains Gopinathan.

The aim of that IIGCC toolkit is to provide investors with a foundational guidance to enhance their stewardship practices and deliver the rapid acceleration in decarbonisation necessary to halve emissions by 2030 to give the world a chance to achieve net zero by 2050.

The Net Zero Stewardship Toolkit is aligned with both the Net Zero Asset Manager and Paris Aligned Asset Owners initiatives and the commitment of initiative participants to implement a stewardship and engagement strategy that is consistent with an ambition for all assets under management to achieve net zero emissions by 2050 or sooner.

“The intention behind that toolkit was to create a stepwise toolkit/ready reckoner for investors who are looking to engagement as a part of their decarbonisation strategy with companies and how to go about it,” says Gopinathan.

The toolkit places an emphasis on companies to develop and implement credible transition plans and how investors can hold them accountable.

“The Net Zero Stewardship Toolkit was well received overall by investors,” he says. “After the launch of that toolkit, we did allude that we would look at other asset classes to expand into, so the launch of the Bondholder Stewardship Working Group is a logical progression.”

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