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Why Fixed Income is key to the future of ESG ?
ESG investment

Why Fixed Income is key to the future of ESG ?

The role of fixed income in ESG, has become increasingly more important and, sometimes, underappreciated by investors.
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There is a general perception that unless you're an owner of the company, that is, unless you’re a shareholder, the say that you have is diminished. But my view is that if you're a capital provider to a company, your say should be on the same level. Our view is that, essentially, all stakeholders, bondholders, equity holders, and employees, all of them have a right to be able to influence the sustainability journey of a company. The misconception that only the shareholders have the right to do so is fading, it has started to change, but that perception is still present.

And the fact is that cash is the oxygen of companies. And fixed income markets can provide the cash that companies need for investment and refinancing on a much quicker basis than equity holders can. And companies need to issue bonds more frequently than they ever come back to the stock markets. We need to keep in mind that the recurring nature, the need for cash at a company level, can sometimes be quite high. Raising money in the equity markets usually takes a lot of time and effort. Nonetheless, with bonds, you can basically do a drive-by deal in a day, if you're a good quality company. So, if a company needs cash, for investment or refinancing, the bond market is much quicker, and more amenable. There is the chance to offer different flavours of securities that companies want rather than just one equity option. And it is obviously cheaper than the stock markets, so the incentive is quite high. 

So in order to be credible with investors who are considering ESG as an important objective that they need to meet, companies need to take fixed income investors considerations into action. I think that is changing, and it is getting better.

The whole new market of labelled bonds

Another factor that is becoming increasingly relevant about the relation between fixed income and ESG is that there is this whole new market of bonds called labelled bonds that has grown exponentially. I’m talking about green, social and sustainability linked bonds among others. And the benefit to the issuer is that, generally speaking, it will be cheaper for them to issue a labelled bond than a normal bond that is not labelled. This is because the buyer base for labelled bonds tends to be stickier, sometimes, funds are created in such a way that they can only buy labelled bonds. So the demand profile for those bonds is quite high.

To be able to issue a labelled bond, the issuer needs to have a credible sustainability strategy attached to it. There are different options here. For instance, the so called ‘use of proceeds bonds’; that is when a green bond or a social bond is issued to fund a specific project. A different new option is what is called ‘sustainability linked bonds’. In this case, there is no direct use of proceeds, the company can raise the money and do whatever it wants with it. But it must set certain sustainability KPIs and if the company doesn’t meet those KPIs, then the coupon on the bonds will be increased. So there is a clear incentive to meet the KPIs.

At the end of the day, fixed income offers companies more flexibility and options and we, as bond holders, speak to companies on a very regular basis. So, the role of fixed income in ESG engagement is becoming more meaningful day by day. 

Finally, to those people who are tempted to see ESG as fad, given that 2023 hasn’t been a particularly impressive year in terms of performance, I would tell them that ESG risks have only grown over the past few years, both on the environmental side and on the social side. And if we don't tackle many of these problems now, these risks will become more pronounced, more frequent, and more costly. So dealing with them sooner rather than later, I think it will make a big difference. In addition to that, there has been a substantial change in regulation, particularly in Europe, that is by far ahead of the agenda, both from an investor and a company point of view. This trend is driving a lot of money to be invested in a more sustainable way. That probably becomes more of a global phenomenon over the next few years, so more capital will flow down the sustainable route. Last, but not least, individuals themselves would like to invest in companies that are doing the right thing. As a result of all this combination of factors, those companies that are considered to be doing the right thing, generally attract more investor interest and are able to raise capital at potentially lower cost than their peers that don't.

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