Bondholder engagement—An important tool for effective stewardship

Engagement is widely seen as an important tool within investors’ environmental, social, and governance (ESG) integration capabilities when it comes to equity investing, however this was—until recently—arguably less commonplace in fixed income. In our view, the increased focus on engagement across the capital structure is reflective of a greater appreciation of the investor’s fiduciary responsibility and an understanding that ESG factors, when viewed through the lens of financial materiality, can potentially impact the value of both debt and equity securities over the short, medium and long term.

We believe that bondholder engagement can, where appropriate, provide valuable insights and an opportunity to share views—be it with corporate or noncorporate issuers of debt. As ESG issues have come increasingly to the fore, there is a greater recognition of their potential impact on creditworthiness. In addition, the fixed income market can provide scope for innovative financing solutions—for example; to target specific environmental and/or social outcomes, such as carbon reduction or financing of green or social projects. Ultimately, this could aid in delivering real world impact, including helping to incentivize and finance a just and equitable transition.

Why engagements can be a powerful tool in fixed income

ESG engagements typically encompass interactions between investors and an issuer of securities with the intent of learning about—or exchanging perspectives on—environmental practices, social issues, or governance issues that are material to the business or security in question.

"One of the advantages of engaging with debt issuers (corporate or noncorporate) is that interactions can occur ahead of a new bond issuance."
Tongai Kunorubwe, Head of ESG, Fixed Income

One of the advantages of engaging with debt issuers (corporate or noncorporate) is that interactions can occur ahead of a new bond issuance. This provides the potential opportunity to offer our perspective—e.g., providing feedback on the proposed debt structure or on best practice for the accompanying public disclosure that is issued concurrent with a deal. We may also exchange views on key performance indicators that would be most useful for investors or discuss ESG‑related concerns that we believe could influence future credit risk. In instances where this results in real world change, this may prove an effective mechanism of delivering investor “additionality,” particularly where bondholder engagement has helped lead to a positive outcome.

Engagements ahead of new debt issuance can play a pivotal role

At TRPA, we apply the same approach to engagement on ESG topics, whether we are engaging on behalf of an equity or fixed income portfolio. We operate an open door policy for issuer engagement meetings so that both equity and fixed income investment professionals can participate.

The objectives of these engagements are often equally valid for both equity owners and bondholders. For example, they may include encouraging improved disclosures or target setting or requesting further information that would help with our ESG assessment of the business.

When it comes to publicly listed corporates, equity holders have an additional tool at their disposal to ensure effective stewardship: voting rights. While bondholders do not vote, we endeavour to ensure a joined‑up message across the capital structure, which includes bondholder engagement with issuers—helping, in instances, to reinforce views that may have also been imparted during shareholder voting.

One other important nuance for bondholders is that they are often providing primary financing and refinancing. As issuers look to meet their financing needs through a new debt offering with its accompanying deal roadshow, they are arguably more incentivized to engage with potential investors, not least to ensure the debt issuance is well received by the bond market. In many cases, our engagements with issuers ahead of a new debt issuance have been instrumental to our investment decision‑making process.

Sovereign engagements on the rise

In fixed income, we engage with both corporate and noncorporate issues. The latter is an area in which we have been increasing our activity in recent years, in part due to the evolution of our research capabilities and the parallel rise in ESG‑labeled debt issuance. We have increased the engagements that we conduct with other types of issuers, including governments and government‑related bodies, as well as financial institutions. We conducted 86 engagements with noncorporate issuers in 2023, up significantly from prior years. In 2024, we conducted 88 such engagements.

Securitized issuer case study: Fannie Mae single‑family social bond

Another example of engagement ahead of an issuance is our interactions with the U.S. Federal National Mortgage Association (Fannie Mae), with regard to its single‑family social bond framework. Fannie Mae enables affordable housing in the U.S. The entity acquires mortgage loans from lenders and either holds these mortgages in its portfolios or packages the loans into mortgage‑backed securities that may be sold. In doing so, Fannie Mae helps provide liquidity, stability, and affordability to the mortgage market, in line with its congressional charter.

Over a multiyear period, representatives from our Responsible Investing, Securitized, and Credit Impact teams collaborated on an engagement with Fannie Mae, focused on providing feedback on their social disclosure for single‑family mortgage pools. This included offering feedback to the Federal Housing Finance Agency, whose role includes being the conservator and regulator of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System (together, “the regulated entities”).

In January 2024, Fannie Mae, alongside Freddie Mac (the Federal Home Loan Mortgage Corporation), announced a new single‑family social bond framework with inaugural issuance later in 2024. To qualify for this social label, mortgage pools had to meet minimum criteria that were outlined in the agencies’ “Mission Index.” We were encouraged by the fact that, under the framework, disclosure spanned 10 criteria, including factors such as high‑needs rural, manufactured housing, designated disaster area, and low‑income census tracts—all of which we believe aligned with the congressional mandate that the government‑sponsored entities operated under. Subsequently, Fannie Mae iterated releasing a disclosure supplement and CUSIP¹ mapping tool available in PoolTalk, its web‑based disclosure application, in addition to an Excel‑based tool that allows investors to derive enhanced insights into the representation of specific populations in their portfolios.

In June 2024, Fannie Mae exceeded USD 3 billion in single‑family labeled social bond issuance. This was launched with enhanced disclosure, which gave us confidence that proceeds were being efficiently allocated to target populations. A number of our portfolios across different strategies purchased the social mortgage‑backed securities issued by Fannie Mae.²

Active dialogues are key to engaging with sovereign entities

Sovereign engagements may take place with central bankers, the debt management office, representatives from key ministries (such as the Ministry of Finance or the Ministry of Environment), or other sovereign representatives.

One of the realities of engaging with sovereigns, though, is the potentially limited level of influence that investors can (or should) have. For governments, one could legitimately argue that their primary stakeholders are their own citizens. In instances, there could be added complexity introduced by the reality that the management of ESG issues tends to be spread across a varied set of institutions and is, in instances, impacted by political cycles.

That being said, active dialogue can enable investors to gain insights, share perspectives relating to disclosures or target setting, and provide feedback on ESG matters that we believe could evolve to become material credit risks. Unchecked, this could ultimately affect the sovereign’s cost of capital—or even in extreme cases, its access to capital markets.

Governments looking to issue labeled debt may be especially open to investor feedback, particularly as this may be new territory for some. Engagement in relation to ESG‑labeled debt can also provide an opportunity for investors to offer more targeted guidance—for example, in relation to the specific projects that could be financed by the bonds or key performance indicators that they would find useful for inclusion in the accompanying disclosures and/or post‑issuance reporting.

In the case of Brazil (see below), the country was arguably somewhat slower than Latin American peers in entering the sovereign market for ESG‑labeled debt. This was despite strong momentum in labeled debt issuance from Brazilian corporates, which are often considered as regional leaders in this regard. We conducted a series of engagements to encourage the government to issue labeled debt and to highlight some of the environmental issues that we viewed as most material to the economy and the nation’s ability to repay its debt in the future.

Sovereign engagement case study: Brazil’s first ESG‑labeled bond

Over the course of 2023, representatives from our Responsible Investing, Sovereign, and Credit Impact teams collaborated in a series of engagements with Brazilian government officials in the runup to the issuance of the country’s first ESG‑labeled bond².

We believe deforestation and biodiversity loss pose a significant risk in Brazil, in part, because the country houses circa 60% of the Amazon Rainforest, the world’s largest tropical rainforest. In our view, robust, peer‑reviewed academic research³ has credibly demonstrated a link between Amazonian deforestation and Brazilian gross domestic product, making this issue particularly pertinent for investors. We suggested that the government consider issuing ESG‑labeled debt, with a focus on environmental issues. Within this, we encouraged the inclusion of deforestation reduction or afforestation projects.

In November 2023, Brazil brought its inaugural USD 2 billion, seven‑year sovereign sustainable bond to market. We were pleased to see that the bond would, in part, aim to finance initiatives to address deforestation control and biodiversity conservation, as well as contributing to the National Climate Change Fund and programs to combat poverty and the fight against hunger. This system’s approach, which arguably recognized the fact that biodiversity loss and climate change are intertwined crises, matches our own perspective.

Demand for the bonds proved to be strong, with the primary issuance three times oversubscribed. Following an assessment of the credibility of the bond, alongside traditional credit and fundamental research, select T. Rowe Price fixed income portfolios purchased the bond at new issue.

Conclusion: Bondholder engagement comes to the fore

We believe bondholder engagement serves an important role for debt market investors, aiding our ability to help fulfill our fiduciary responsibilities as an investment adviser, as well as being a key part of effective overall investor stewardship and offering the potential to create investor additionality.