Chandra Gopinathan on bondholder stewardship: ‘We have to create new accountability mechanisms’

With rates rising, bonds have appeared to make a comeback in institutional asset allocation. And for many, such as insurers and mature defined benefit schemes, they have never truly been gone. But this raises the question: what measures can investors take to bring down the carbon footprint of their fixed income portfolios?

Net Zero Investor sat down with Chandra Gopinathan, a senior investment manager in  Sustainable Ownership team at Railpen. In addition to his day job for one of the UK's largest defined benefit schemes, Gopinathan chairs the Bondholder Stewardship Working Group for the Institutional Investors Group on Climate Change. He is also a member of the Transition Pathway Initiative (TPI) and the FCA Climate Financial Risk Forum (CRRF). 

Gopinathan will be a speaker at this year's Net Zero Investor Annual Conference on 11 December. Ahead of the event, we sat down with him to discuss the challenges of creating greater accountability of climate efforts among bond issuers. 

A lot of stewardship efforts has been focused on equities but for many defined benefit funds bonds still account for most of their portfolio. What efforts are being made to tackle the carbon footprints of bond portfolios?

You are right, a lot of the stewardship focus is on equities, there is also a lot of activity for bond portfolios, but it is more fragmented and not very standardised.

Part of the goal of the Bondholder Stewardship Group is to bring that standardisation, both in the engagement process with existing bond holders and in the engagement process of new bonds and structures.

We have tried to take a life cycle approach towards bondholder stewardship. What I mean by that is to balance the long term approach needed for climate stewardship, the maturity of the bond portfolio and the alignment between the bond issuance and the issuer’s climate targets and transition planning.

Investors need to view this more holistically and connect the dots between the issuance, the climate alignment status and the issuer’s overall transition plan and targets.

The second thing is to use an ecosystem approach. When you look at the bond market, there is an entire ecosystem of participants involved. You have the arrangers, the banks who lend and their loan books and the debt capital market syndicate and structuring teams who work on covenants, maturities, documentation etc, Then you have the regulators who are also involved, rating agencies and third-party service providers who provide green bond assessments. All these people have to be included and aligned in the process.

Net Zero Investor's Annual Conference | 11th December 2023 | London

What we are advocating is yes, talk to the issuer but make sure you are using the same language everybody else is and speak to everybody in the same ecosystem as well.

We went over these things for specific sub-asset classes within fixed income. Mind you, we didn’t touch on sovereigns, it was mostly, corporates. We’re talking about investment grade, high yield, structured products and public debt issued by private companies.

What we also did is bring in a lot of case studies, we have brought in best practice case studies to show what is already being done, to bring it to life.

There was also an FCA consultation on non-equity securities earlier this year, what were the positions you put forward in the consultation?

This was about what the disclosures need to be from an ESG standpoint, particularly around labelled and non-labelled debt securities.

We partnered up with the IIGCC [Institutional Investors Group on Climate Change] for the consultation response. What we are pushing for are similar disclosures to TCFD and an ISSB /IFRS standpoint and include these as part of bond prospectus and indenture disclosures.

One of the biggest issues with bondholder stewardship is that there isn’t really an accountability mechanism. Everybody talks about debt denial but if you are staying invested in the bond to be able to engage, you don’t really have any legal hooks right now.

What we are trying to do is start the discussion around prospectus disclosures and indenture disclosures around climate and net zero considerations. If the issuer has climate considerations and net zero plans, there is no reason why they couldn’t disclose that as part of their prospectus. What is your emissions footprint, what is your target? That way investors can do an alignment assessment and see if the bond is actually aligned to the issuers transition plan or not.

An issuer might say, I am issuing this bond and this is my use of proceeds, but that may not line up with the issuers transition plan but that may not line up with the transition plan every time. That is the disclosure that we are looking for, hopefully it will come through.

Could bond covenants also play a role in engaging on climate targets?

Yes. Even light covenants such as restrictions on permitted acquisitions and indebtedness, not being able to borrow more if you are not reaching your climate targets and being able to have limitations on dividends are options. These restrictions are not new to the bond markets but haven’t existed as part of climate considerations.

What we are trying to do is say: Why don’t we extend these concepts, why don’t we put them in an ESG or climate context and talk about covenants.

This is something we need to still flesh out with issuers and debt capital markets, but this is the direction of travel in which we are going.

SLBs / sustainability linked bonds and their related disclosures also offer strong tools to engage with issuers.

Could investors also simply opt for green- or similarly labelled bonds?

These bonds are a voluntary framework which does have its flaws but it they does offer investors opportunities, particularly sustainability-linked bonds, to assess whether or not the issuer is doing the right thing.

Some issuers may have SLB’s but are blatantly greenwashing, others have SLBs which are fully aligned with their transition plans. What we are trying to do is give investors an objective framework to assess these SLB’s.

We will focus on things like the KPI’s associated with these targets, sustainability performance, targets by sector and also step-up mechanisms and how they can be structured. All of these become hooks to go back and assess the issuers. They all provide hooks for stewardship in our opinion.

You mentioned introducing climate targets into bond covenants. But how can this actually be enforced? Should the regulator play a role here?

To be clear, this doesn’t currently exist but the way to start is to make sure the disclosures are in the prospectus. Once you have the disclosures on who is doing well and who is not, then you can start the discussion on covenants. It is one step at a time but we hope that the first step is that we can get the FCA to approve these disclosures. But we are not there yet.

Do most of the bond holders you work with intend to hold their assets on a buy and hold basis? Does that mean divestment isn’t really there as an option?

Divestment is there as an option, but we tend to not make it the first option. And it is not just buy-and hold. There are also active managers who tend to hold securities for a long time which is still a good reason to go in and engage with a company. Particularly if you are going to reinvest.

You mentioned the issue of greenwashing in green bonds. How much is that still of an issue, is there now greater transparency?

There is greater transparency, but both labelled and unlabelled bonds carry greenwashing risks You have companies that issue through “green” subsidiaries, but the money might go back up to their holding company, you have issues where companies have targets that relate to just the bond but that may not line up with their overall targets. Or the company may not have overall targets, but the bond has. there is misalignment in being able to use these frameworks and still not doing much at the corporate level. We are trying the bridge the gap between the two: What you are doing on the financial planning side should be similar to your overall company side. Over time, these are just tools to get to your net zero goals, but you need to use these tools.

There has been a lot of talk of the ‘greenium’ in green bonds with issuance often being heavily oversubscribed. How have rising rates impacted the dynamic?

The oversubscription challenge is still there. There is a lot of research that has been done on the greenium and the evidence is there- for both sides. But the challenge does exist: You can have situations where investors may go and subscribe to the whole thing, in which case the issuer gets what they want by just paying a little bit more.

Our focus is less on the absolute pricing and more on basic accountability mechanisms because right now, there are none. Once we can get the correct legal documentation, covenants and disclosure are in place, then the market can decide how they want to price one asset versus another.

But the bulk of pension assets, at least here in the UK are invested in sovereign debt. What are you doing on that front?

Hopefully next year we can go more into sovereigns, there is a sovereigns engagement group which is called ASCOR [Assessing Sovereign Climate-Related Opportunities and Risks] which is already running. We hope to collaborate and partner with a few of these groups to see how we can move this forward on the sovereign side as well.

What are some of the issues you might be facing when assessing the carbon footprint of sovereigns?

It is different which is why we have kept it separate. From a climate perspective, corporate bonds and equities are more aligned. For sovereigns, a few things need to happen. Investors need to better understand what stakeholder mapping needs to look like. I need to know who I need to be talking to, the basics of the sovereigns carbon footprint and pathway, it’s own energy mix and policy around that. You really need to understand what they need to grow because you don’t really want to stop their growth, particularly not in emerging markets.

There are some data providers that do that, like the German CCPI does it, but that is the first step, to understand the footprint of sovereigns.

Once you have a good foundational picture, you can start looking at the opportunities, can you do equities, sovereign bonds, local currency bonds. From a capital allocation perspective, the just transition partnerships are also a potential allocation. But this is a long process, the first step is to do the research, understand who the stakeholders are, it is even more fragmented than corporate bonds.

If you measure the carbon footprint of a country, do you focus on Scope I and II or do you also include Scope III?

There is a lot for investors to think about. The first thing is, what kind of questions would you have to ask? What does Scope III even mean for a country? Are we talking about produced or imported emissions. If you are looking at Bunds, are you looking at all the coal fired energy imported from the Czech Republic? These are big questions to ask but again, disclosures are the first step. Scope III is a different discussion altogether.

Do you think we will ever get to a point where we will see green bond vigilantes holding governments to account for their backtracking on climate targets?

It’s an interesting question, I haven’t seen the media talk much about the backtracking on targets or much in terms of substantive public questioning. There is definitely room for more vigilance and questioning. Asset owners and investors are doing what they can in terms of capital allocation. With equities they can vote, with bonds they don’t have the ability to do that, they can not buy them but there is very little they can do. There are limitations in how far they can go. But we have to create these accountability mechanisms first, which is what we are trying to do.