Feature ESG – Bonds
“One of the successes of the green bond story is that a portfo- lio manager, in most cases, will be indifferent to buy green or conventional debt. That means volumes in terms of capital allocation for these transactions.” Gordillo continues to explain that the “greenium” is small in the secondary market and is more visible in euro-denominated transactions. Europe has more buy-and-hold investors, which creates less liquidity therefore driving markets down, but he makes it clear that transactions in primary markets are not more expensive.
This increases if a green bond is issued from another part of the market. “There is a demonstrative “greenium” in some of these securities, which can be a little more pronounced when you are in some of the brown industries,” Reznick says. “There is greater demand here because if you are building a diversified sustainable portfolio, it is difficult to include the brown industries, which have an element of cyclicality in them. But if a brown industry company issues a green bond, you obtain the diversification and sustainability benefit from the debt. “As a result, they can be overbought because no one wants to sell them,” Reznick adds. Ultimately, when it comes to the return, it is equal to the risk taken. “A good ESG company is a company with lower risk,” King says. “Risk and reward are linked in bond markets, and so strong ESG companies tend to trade tighter than problematic names.”
We can work it out Creditors do not get a vote at AGMs, so the influence they have over a corporate may not be as strong as it is for shareholders. But where bondholders could be effective is by refusing to lend money to corporates, especially as they typically make several visits to the bond markets. “We can influence the cost of capi- tal,” Freedman says.
“In terms of who has more power – the lenders or the issuers – it ebbs and flows depending on the conditions in financial markets,” he adds. Issuers typically need to refinance their debt when it matures. “This is a crucial moment to share with issuers our expecta- tions on their climate change actions or if we are unconvinced by their sustainable strategy,” Gordillo says. Reznick has had similar experiences. “Engagement is also effective when companies have a recuring presence in the cap- ital markets. In the case of fixed income that is annually. It is almost like a recurring IPO as they approach the market to refinance existing debt,” he adds. So, there is a point when a bondholder has influence over a cor- porate’s board. “Timing is crucial when working to make issuers more sustainable,” Nietsch says. “The conversations that hap-
38 | portfolio institutional | May 2021 | issue 103
pen before issuance are when we have the greatest influence.” Newton has been working closely with a couple of issuers to help them understand what constitutes best practice in ESG, and to enhance and refine their ESG disclosures and reporting. “Bond issuers recognise they have to be more accountable, and therefore they are more open to hearing input from investors. Ultimately, that communication will improve the sustainability of issuers and their unlabelled bonds,” Freedman says. For some, bondholders have as much right to a say in how a corporate is run as shareholders do. Voting should not come into it. “The right to engage with a company is predicated in the financial stake-holding that you bear,” Reznick says. “In the US and EMs, we have seen companies we have engaged with establish science-based targets and issue sustainability-linked bonds. “If the largest companies at the end of the value chain are responding to government calls to reduce their carbon foot- print, companies are a lot more amenable to engagement than they were because of the direction of regulatory change and increasing disclosure requirements,” he adds. So, speaking with management as a bondholder can be just as effective as speaking with them as a shareholder. “Engagement is different in the bond market than for equities, but it does not prevent bond managers from engaging with issuers,” Amundi ETF’s Guignard says. Allianz’s Pellegrini calls for investors to take a “humble and realistic” approach to what can be achieved in engagement. “We can push issues and make emerging market sovereigns and corporates aware that we demand explanations on certain points. “We expect a high level of engagement with the emerging mar- ket corporates and sovereigns that we invest in,” she adds. For BNP Paribas AM’s Gordillo, engagement is just one of three areas where ESG is changing the way the asset manager works in fixed income. “We engage with pure fixed income players, but an interesting development is engaging with sov- ereigns. This is new in the market. We are doing it. We are learning,” Gordillo says.
The second is its role in credit analysis. “There is a movement for ESG as a tool to complement the assessment around default risk, thus enhancing the credit assessment framework.” The third development is thematic bonds. “Last year we saw the emergence of the social bond market, in part because of the Covid response. We also see other structures, like SLBs,” Gor- dillo adds.
A catalyst?
The green bond market is growing, but it is still a small part of the global debt market. Another concern is that issuers tend to be concentrated in a few sectors. So, could the UK’s plan to
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