Denying the debt needs a solid game plan

Investors need to pick their battles for the concept of "deny the debt" to work in pushing global companies closer to alignment with the Paris Agreement on climate change.

"It's not necessarily the highly credit-rated big firms we are looking at first," said Andreas Hoepner, professor of operational risk, banking and finance at University College Dublin's Smurfit Graduate Business School. "Instead, we're looking at those with lower credit ratings because those are the ones not oversubscribed" when it comes to bond issuance.

The weakest links in the fossil-fuel value chain — or any ESG issue — are companies "with the highest risk operations and low credit ratings. That's the type of firms where if they don't get refinancing or (experience) higher costs, bigger firms might end up having to internalize risks which they would prefer to have externalized."

"It's gradually tackling the polluting supply chain, not necessarily the biggest firms first,'' Mr. Hoepner said. "Here the most impactful thing is winning the smaller battles and gradually isolating the bigger firms."

For example, if 10% or 20% of investors involved in the Climate Action 100+ initiative, which works to ensure the largest corporate greenhouse gas emitters take action on climate change, were to engage in debt denial, "this could have a huge impact on the weakest links in the polluting supply chain," Mr. Hoepner said.

Trying to shape outcomes at the refinancing point is something that has been exercised on the sovereign side of fixed income, said Carmen Nuzzo, head of fixed income at the Principles for Responsible Investment in London.

Where a government defaults, and there have been a few emerging market examples of this recently, investors will come together and discuss the conditions under which they could restructure the debt.

And the reputational impact from a decision to deny debt to a company should also not be underestimated. "Divestment is very powerful and it grabs the headlines, and that factor should not be understated. But equally, if somebody divests, somebody else buys. Is it really a valid proposition to dump an investment? I'm not underestimating the power of the announcement effect — but it's equally important to engage with the issuer and accompany the issuer during the transition to a more sustainable model," Ms. Nuzzo said.

The current almost-zero rate environment is also a factor in how successful debt denial may be, she added.

"We have to put the engagement into context as well – we live now in a world of QE in Europe and in the U.S., yields are very low, so is this threat really achieving anything, because companies can (afford) to fund themselves anyway if they offer investors a bit of positive yield. That's why I think engagement as a dialogue is much more important. Future lending should be more conditional on maybe ESG targets," Ms. Nuzzo said.

Other sources agreed that adding ESG factors into bond covenants could be another powerful negotiation tool when it comes to providing capital.