ESG-specialist Emma Whiteacre distils the conference outcomes into the key insights for fixed income investors.
Following a frenzied build-up, COP26 proved to be somewhat of a mixed bag.
Progress on deforestation was notable, with 110 countries, including rainforest heavyweights Brazil, Indonesia and the Democratic Republic of Congo, signing a global pledge covering 85% of the world’s forests – welcome news to BlueBay as co-Chairs of the Investors’ Policy Dialogue on Deforestation.
Other important commitments on methane and cars were made, although important players were absent. A deal to help South Africa transition away from coal, worth USD8.5 billion, was warmly welcomed and could prove a model for other countries. The final Glasgow Climate Pact broke new ground in its mention of fossil fuels, but disappointment was palpable as China and India watered down the language to commit to phasing ‘down’ but not ‘out’.
Beyond the headline commitments, the long-term impact of the conference will be determined by the implementation. Much will depend on commitments by the rich world regarding finance, trade and technology transfer to developing countries. National-level pledges to reduce emissions must be implemented through fundamental changes at every level of the real economy, from local to global.
As investors, we can take an active and influential role in evoking change. The trend to reduce the carbon intensity of portfolios is one that is rapidly gaining momentum.
While coal usage may linger in China and India for some time, the direction of travel by the Western world is clear – coal is being phased out and portfolios must reflect this. How successfully this can be achieved will depend heavily on data availability. Carbon-footprinting a bond portfolio is no easy task (click here to read more on this).
As well as what we invest in, we also have the choice of how we structure investments. In fixed income, that is best addressed through the types of bonds held.
There’s lots of innovation taking place around green bonds and ESG financing and this is set to continue – COP26 has only added to the momentum. We expect to see green issuance levels increase as investors move away from vanilla bond structures across sovereigns, corporates, developed and emerging markets – it’s a universal story and a one-way street.
On top of this, we’re seeing investor engagement levels increase across the industry. Bondholders aren’t owners, so they don’t have the right to vote like shareholders do – but that doesn’t mean our voices should go unheard.
The fixed income universe totals some USD128 trillion, dwarfing the equity market at around USD35 trillion. The bondholder voice is most influential at the primary issue level. As individuals or a collective, bondholders have the power to financially back or withdraw support for new issuance and help shape its parameters.
For example, with sustainability-linked bonds, investors can stress that the KPIs be material to the issuer’s ESG profile. With green bonds, they might push for specifics on how the issuance proceeds are used. The role fixed income investors can play in shaping issues should not be under-estimated.
One of the most effective ways investors can maximise their influence is through collaboration. A combined voice can sometimes yield change that may not be possible as an individual, or which would have taken much longer to achieve alone.
While the jury may still be out on whether COP26 can be judged as a success, there are clear take-aways for investors. Decarbonisation trends are only going to grow in importance; a greater number of ESG-focused bond structures will come to market and fixed income investors can play a crucial role in allocating capital so it supports the world’s climate change agenda.
To learn more about ESG engagement, see our paper ‘Unlocking the bondholder’s voice’.