In February 2020, Neuberger Berman had the privilege of welcoming CEOs, CFOs, and investment relations leaders from thirteen high yield bond issuers for an in-depth discussion of environmental, social, and governance (ESG) engagement in the non-investment grade credit market. These issuers account for over $44 billion in high yield issuance across various sectors, including financial services, energy, manufacturing, industrials, and telecommunications, among others.
Representatives from our Non-Investment Grade Credit and ESG Investment teams hosted a roundtable in Miami to understand how evolving interest in ESG from investors has changed these issuers’ approaches to sustainability. Coronavirus and the current economic downturn have highlighted the private sector’s role in solving social challenges and put a spotlight on credit markets, especially non-investment grade credit. In this environment, understanding market expectations for ESG engagement and best practices is more vital than ever.
Doubling down on transparency
The roundtable began with an overview of Neuberger Berman’s perspective on ESG for non-investment grade credit, drawing on both input from our clients and our experience investing in this area. Chris Kocinski and Joseph Lind, Senior Portfolio Managers on the Non-Investment Grade team, introduced the discussion by sharing the substantial and growing interest in ESG among Neuberger Berman’s clients. They wanted to know how issuers are managing key ESG risks and communicated that investors expect nuanced and consistent reporting that enables them to account for these factors as they diligence companies.
Jonathan Bailey, our Head of ESG Investing, spoke next to discuss both the role of ESG in Neuberger Berman’s investment process and our experience incorporating these factors into our own management and strategy. On the investment side of the house, our team identifies the ESG risks most material to an issuer’s credit profile and develops a granular view of how those risks might materialize. This approach—which treats ESG performance as a way to mitigate issuers’ downside risk—requires disclosures detailed enough to provide the data needed for our analysis.
Neuberger Berman’s clients want the same. As their focus on ESG has increased over the past several years, their demand for transparent reporting has, too. In particular, our clients view materiality as the gold standard. While sector-agnostic disclosure guidelines lack the nuance investors need, standards like those promulgated by the Sustainability Accounting Standards Board (SASB) and Global Reporting Initiative (GRI) tailor metrics and disclosures to the factors that actually drive performance in each sector.
Neuberger Berman’s emphasis on materiality is emblematic of a broader move toward a bespoke approach for ESG disclosure. Some of the privately held issuers in attendance raised the question of whether transparency expectations differ by size or between public and private markets. Our experience suggests they do. In general, the disclosures expected of large, mega-cap companies are greater than those for small-cap firms. Particularly for private companies, the journey matters more than the starting point. This is exactly the approach Neuberger Berman takes with companies in its credit portfolio: identifying material factors, developing clear ESG performance goals, engaging with issuers and measuring progress over time.
As interest in transparency has grown, so too has clients’ emphasis on rating agencies. Roundtable participants discussed where to focus their efforts with ESG rating agencies and how to engage them while protecting their commercially sensitive information. The first step should be to understand the rater’s methodology: what are they looking for and what data is needed for the assessment. When it comes to commercially sensitive disclosures, investors and rating agencies do not expect issuers to compromise their competitive positions by disclosing protected information. Instead, these companies can work with rating agencies to ensure ESG-relevant, sensitive information is incorporated into ratings without publicly distributing it. On this view, engagement with raters is a way to send a positive signal to the market while still protecting valuable information.
The Next ESG Horizon
After concluding their discussion of ESG disclosure, the attendees turned their attention to forward-looking opportunities to address ESG challenges. Several issuers in energy-intensive sectors asked how they could overcome the perception that they are perpetually lagging. They wanted to understand how they can rise above the tendency of some ESG-aware capital to dismiss their entire business model due to its dependence on fossil fuels.
Representatives from Neuberger Berman and these companies agreed that one approach is to set ESG goals that separate them from industry peers. Attention to ESG does not impose an absolute standard that ignores crucial differences between issuers’ underlying business models and starting points. For example, Neuberger Berman has invested with Talen Energy, an attendee at the roundtable, because their track record of reduced emissions, safety improvements, and future-oriented positioning in the energy industry matters more than the mere fact that some of their generation capacity comes from coal. From our perspective, what matters is not a company’s starting point, but rather how capital is deployed and whether the firm has a comprehensive forward-looking plan. Talen noted that current ESG conversations may focus too much on single issues, such as carbon footprint. They pointed out that conversations and plans regarding the transition away from coal generation must also include social aspects and consider the impact a plant closure may have on local communities. Neuberger agrees that meaningful changes will involve deep engagement, thoughtful planning and the incorporation of all aspects of investment diligence.
Several issuers also raised the issue of how to manage variance among investors’ ESG approaches. Differences in disclosure expectations, engagement style, and investment process can make it challenging to please all parties on the buyside. As they discussed this challenge, roundtable participants came to an agreement that full consensus is often unrealistic should not be their objective. After all, that’s what markets are for: to allow various investors with divergent goals to price securities differently. Rather, issuers should focus on understanding industry “best practice” with an eye toward materiality and get ahead of communicating and managing toward that standard.
This is one area where Neuberger Berman can work with issuers to meet these expectations. Our broad client base and dedicated internal ESG expertise enable us to work with issuers to develop comprehensive ESG strategies that respond to their stakeholders and are tailored to their sector. Toward the end of the roundtable, the discussion turned to the question of engagement, both external and internal: how to proactively communicate these business decisions to investors and how ESG professionals can engage senior management at their own organizations to implement ESG goals. One approach favored by participants is to adopt a materiality lens to focus these communications. To illustrate, take a look at your last investor presentation and ask whether the attributes highlighted qualitatively—like employee satisfaction and charitable activities—can be replaced by a set of a few material metrics. Others emphasized the need for coherence between internal and external communications: What employees hear communicated to investors and the public should match their experiences inside the company. Employees listen to what management says about ESG, and those communications should resonate with them.
Neuberger Berman’s Role
Working with issuers to develop their ESG strategies is a crucial component of our investment approach. But Neuberger Berman’s commitment to ESG and transparency goes beyond our decisions as an investor. Earlier this year, Neuberger Berman became the first asset manager to sign an ESG-linked loan that links borrowing costs to our performance on metrics like engagement, diversity, and employee ownership. As a recipient of credit, we try to “walk the walk” by holding ourselves to the same standards to which we and our clients hold issuers.
This dual perspective as an investor and a borrower enables Neuberger Berman to work with issuers to develop their approaches for ESG disclosure and update their business practices accordingly. The collaborative approach Neuberger takes was highlighted by Talen’s President and CFO, Alex Hernandez, who commented: “Neuberger Berman has been a thoughtful and long-term partner in our efforts to incorporate ESG factors in Talen’s business plans and investor communications. They have a unique understanding of our business and the materiality of the ESG factors that affect us. The roundtable and discussions in Miami were a productive continuation of this collaboration.”
The Path Forward
We would like to extend our sincere thanks to all of those who joined this year’s roundtable and look forward to continuing this discussion. If there is one takeaway from this year’s event, it is that ESG best practices for issuers will continue to evolve and grow. We look forward to helping shape that debate and encourage those interested in joining the conversation to contact us for more information.
