Traditionally, engagement has been seen as the domain of equity investors, simply because shareholders have a right to vote on a range of company matters.

Debt investors have no such rights. However, pretty much every asset manager involved with bonds will swear they are active in bondholder engagement. Why would they do that, with no rights? Whether or not they would, there is a growing consensus that they could because a majority of debt outstanding has a maturity date and will face refinancing at some point. And because large companies have lots of bonds outstanding, which creates a constant recurrence of refinancing moments. At these moments, any creditor can say no. If it is just one bondholder, it is unlikely they will be noticed by the company (they have no vote, remember, and in a world devoid of yield, companies will easily find a replacement investor). But if more than just one bondholder refuses to buy the next new issue (ie, refinance), a treasurer may start to take bondholders’ demands seriously.

Bondholders are reluctant to push for stronger action We wanted to know whether bondholders were ready to consider such a move in order to influence issuing companies’ strategies, so we conducted interviews with more than 20 bond market participants, publishing a report on the results called Sleeping giants – are bond investors ready to act on climate change? We found that bondholders are generally reluctant to use their influence to press companies for stronger action, eg, on climate change, particularly in a coordinated fashion. This reluctance is due to a multitude of reasons, including two in particular: one practical and of immediate relevance to the portfolio manager, the other fundamental and crucial to the question of whether the investment sector can be expected to contribute significantly to the environmental and social challenges the world is facing.

The first reason why no one is willing to consider coordinated engagement (beyond ‘constructive’ dialogue that we would dub ‘tea-and-cookies’ engagement) is the bouquet of rules that one could fall foul of: seeing to be acting in concert (with the potential consequence being a mandatory bid for the issuing company), seeing to be acting anti-competitively (potentially incurring hefty fines), seeing to be engaging in market abuse (potentially incurring custodial sentences of up to seven years and unlimited fines). No sane investor is going to risk any of it. So, unless financial regulators can provide satisfactory assurance on what practices can be considered safe, or unless a mechanism can be found that clearly doesn’t conflict with those rules, it is unlikely that bondholder engagement will do much good.
Bondholders are generally reluctant to use their influence to press companies for stronger action on climate change

The second reason asset managers are reluctant to engage beyond fact-finding is that they do not believe they have a mandate to do so from their clients. Since most investment management agreements (IMAs) limit the specification of objectives to some expression of return and risk parameters, the focus on sustainability impacts (more on that in a moment) will fall outside of the mandate in most portfolio managers’ eyes. And arguing that engagement helps improve returns and reduce risk (eg, by gradually improving a company’s rating, thus leading to a tightening of credit spreads of outstanding bonds) is plausible on the equity side, but likely to be dismissed on a cost-benefit basis for an asset class where potential returns are becoming smaller and smaller, and risk is either accepted or sold out of. So, if we expect bond portfolio managers to influence issuing companies, we need to make it a proper objective for them.

And this goes to the root of the problem, not just on the bond side, but for all asset management: the orthodox framework that investment management adheres to is one of two dimensions: return and risk. Now, because ESG aspects have been understood to pose financial risk to investors, particularly bond investors, they have been happily absorbed into financial analysis, under the risk dimension. And with that, investors largely believe that the issue of sustainability is sorted.

Consider the impact This is a notion we disagree with. If environmental or social issues are just another matter of financial risk, then investors will continue to do what they are used to: take risks, if they are priced adequately in their view. Climate change risk sorted. No need to eliminate the risk’s root cause.

If, on the other hand, we want investors to work towards achieving the Paris Agreement, we will need a dimension beyond risk and return that any financial decision must incorporate. That third dimension is impact. Not, one hastens to clarify, in the sense of positive impact investing. But in a sense of the sum of footprints, of all externalities. According to the Global Reporting Initiative (GRI), impact refers to “the effect an organisation has on the economy, the environment, and/or society, which in turn can indicate its contribution (positive or negative) to sustainable development”. If we can get asset owners to write impact objectives into their mandates, we will get asset managers to start pushing for impact. Telling companies that they should align with the Paris Agreement is an impact objective. Of course, faith-based investors have for a long time known how to introduce their impact objectives: through exclusions. But excluding an issuer removes the need for engagement, and the decision is made by the asset owner, not the asset manager. If we want asset managers to be part of the effort, then an impact framework is needed.

In conclusion, if bond investors are to use the power they have over issuers through bondholder engagement, then the possibility of investors not supporting the re-financing of maturing debt needs to be on the table. This will only happen if bond investors a) can be assured that they are acting lawfully, and b) have a mandate to pursue impact goals. Without these conditions met, bondholder engagement will never truly pack a punch.