Mark Hynes - thoughts on corporate disclosure

Opinions on changing rules, changing best practices, and their effect on investor relations officers.

Monday, September 06, 2010

Engagement on governance issues by debt holders?

Hands up, who has heard of the European Federation for Retirement Provision? No, didn’t think so. And yet they have made a really important point in their contribution to the ongoing EU-wide stewardship debate. Governance – and the ES bit – should not just be about shareholders, it should include bond holders as well.

What are – or should be – the appropriate levels of corporate governance involvement by corporate debt holders, and what would constitute an acceptable IR strategy for engaging debt holders?

First, the scale of the problem. There has been a noticeable shift in pension funds’ investment strategies. The trend for UK pension funds to include investment in bonds, and particularly corporate bonds, has been apparent for the past few years. As the pension time bomb ticks, bonds are increasingly seen as a better match for the funds’ liabilities, and pressure to match those liabilities has increased from regulators, sponsors and trustees.

Meanwhile, “engagement” is largely seen as being about equity, but what if an investor’s equity strategy on governance and other issues is different from its debt strategy? We recently saw the corporate bonds of BP being shorted for example.

How much engagement should companies have with debt investors, when corporate bond holders do not get a vote at the AGM? Where do bond holders have leverage over companies on environmental, social and governance issues?

The easy answer is just to accept that bond holders don’t vote and do nothing. After all, lenders should be entitled only to repayment of the agreed amounts. Since they have no future direct claim on the future profits of the business, why should they have a voice on how the company is managed for the long-term?

But if trustees investing in corporate bonds believe they should engage with companies, the time that corporate bond investors can do this is when the company issues a bond. Will we see debt investors asking for covenants, that are normally linked to financial ratios, ask for other “social” rated covenants?

As defined benefit schemes mature, moving more into corporate bonds, and investors are “encouraged” by Stewardship Codes to engage with companies, there needs to be consideration on engagement for corporate bond holders. Time to dust off that debt IR strategy.


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