According to ShareAction, institutional investor engagement with companies on climate-related risk is becoming widespread. However, in today’s capital markets, engaging with firms on Environmental, Social and Governance (ESG) issues is largely seen as an activity for equity investors. This comes despite the fact that fiduciary duties are a universal responsibility, implying that both debt and equity investors should be engaging companies.

ShareAction notes that bond investors have collaborated to engage companies effectively on ESG issues previously, thus demonstrating that collaborative engagement can and should be adopted by bond investors as a tool to manage material ESG and climate risks.

To understand the role that bond investors see themselves playing in the corporate engagement space, ShareAction undertook 22 in depth interviews with asset owners, bond managers, issuers, and other experts from the United Kingdom (15), Europe (6) and the United States (1). Additionally, ShareAction explores the key differences between corporate engagement for equity investors and debt investors, drawing on the structural nuances of debt and equity (e.g., turnover rate and cost of capital) to contextualise these differences.

Building on the work of the Principles of Responsible Investment (PRI), this report had three main objectives:

• To open discussion with asset owners and asset managers on the methods and benefits of engaging with corporate bond issuers on climate related financial risks
• To establish appetite for preferred engagement strategies
• To explore perceptions of how ESG and climate issues affect credit risk

Based on the interviews and other evidence gathered, ShareAction presents several key recommendations for asset managers, asset owners and regulators. These include:

• Climate Action 100+ signatories and PRI members should commit to engage and escalate across all asset classes: for bond fund managers, this could include challenging high carbon issuers to ensure business models and capital expenditure plans are compatible with the Paris Goals. And for bond investors, this means setting clear paths to escalate engagement where issuers have not published information assessing progress towards climate targets.
• Asset owners need to take responsibility: asset owners should not blindly rely on asset managers to undertake their fiduciary responsibility but take a pro-active approach and discuss a robust engagement and escalation strategy with their fund managers for high emitting issuers across all asset classes, including corporate bonds.
• Regulators and supervisors need to enforce fiduciary responsibility: by simply providing clear guidance on collective engagement to temper concerns around concert party issues, explicitly referencing debt and equity when introducing rules on accounting for financially material issues like climate change, and introducing explicit guidance on bond investor stewardship by financial reporting bodies.

Overall, the report indicates that bond holders can be influential players in the climate action space. Yet several key barriers to integration of climate and ESG risks still remain. However, even those that question the relevance of addressing climate impacts at present agree that there is power in intensifying corporate engagement, and that a collaborative and coordinated approach can an effective tool in lobbying for climate action.

1. The survey results presented in this ShareAction report give readers an insight into bond holder sentiment regarding the appetite for integrating climate risk into investment decisions concerning debt instruments. It encompasses a broad range of perspectives from different geographies, thus making its findings relevant to asset owners, asset managers, financial market supervisors and policy makers from across the globe.
2. ESG risk is seen as relevant to bond investment: almost all interviewees understand that ESG is a manifestation of downside risk. For most, there is no question that the analysis of non-financial risks need to be integrates into the investment process.
3. Currently, data complexity and accessibility present significant barriers to integrating climate change factors into risk models. This means bond investors are not able to make ESG and climate change integral parts of their investment decision making process.
4. Bond holders openly acknowledge that divesting from sectors should be approached with extreme caution, stating that even significant ESG risks will be absorbed if the uptick in yield is high enough. However, despite this caution divestment from a specific issuer’s bonds, and refusal to refinance/roll over corporate debt are agreed to be potential points of leverage for debt holders to exploit when lobbying for climate action.
5. The idea of a bond investor collaboration is viewed with unease: Collaborating around engagement with issuers or publicly communicating conditions for continued investment are widely considered to be legally problematic. However, a small minority would consider this action.
6. Views on Green Bonds are mixed. Most interviewees said they would buy green bonds if the return was not diminished compared to conventional bonds, noting that the added transparency of a green bond is a bonus. However some said they did not understand the purpose of green bonds and questioned the stated impact of these bonds.
7. Bond investors are focusing on mitigating portfolio level climate risk, but not climate change itself: the bond investors interviewed think about the implications of climate-related risks for portfolio management and asset selection, but are not yet focused on the impact of the investment itself on climate change. The question of how to limit global warming to 1.5 - 2 degrees is not a question they believe they need to answer.
8. To deal with the emerging impacts of climate change itself, investment objectives need to include a third dimension to the traditional dimensions of risk and return: Real-world impact.