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In recent months, several telecom companies with operations in emerging markets were faced with corporate governance issues. These issues had huge consequences and highlighted the negative risks for bondholders. They show that integrating environmental, social and governance (ESG) factors into the analysis is key in assessing the downside risk of credit investments.
One of the cornerstones of the investment philosophy of Robeco’s Credit team is that avoiding losers is more important than picking every winner. This is a direct consequence of the fact that at best bond investors get their money back plus compensation in the form of interest, where on the downside they could lose it all. Analyzing ESG information helps us to understand the downside risk better and spot potential losers.
In this article we focus on the ‘governance’ element in ESG, or to be more precise, corporate governance. Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way in which a company is run. It also includes the relationships among the many players involved (the stakeholders) and the corporate goals. Stakeholders include shareholders, management, and the board of directors but also employees, suppliers, customers, banks and other lenders, regulators, the environment and the community at large.
In emerging markets, companies tend to be confronted with corporate governance issues more frequently than in developed markets. Examples are having criminal partners or the more common practices of bribery and corruption. Some telecom companies, for example, have been asked to make illicit payments to obtain licenses in certain emerging markets. We think that in some cases telecom companies have not properly evaluated the risks of doing business in these countries at the time of entering them.
Recently several telecom companies have had to deal with corporate governance issues related to their business in emerging markets:
One of the reasons that these matters are becoming a bigger issue is that the US Department of Justice (DOJ) has moved its focus to the telecom sector. At the same time, the DOJ wants to hold individuals, mostly corporate executives, more accountable for corporate wrongdoing.
As these examples show, (telecom) companies are more likely to be confronted with issues like having criminal partners or the practice to bribe politicians to obtain licenses in emerging markets than in developed markets. In addition, they demonstrate that corporate governance issues can have far-reaching consequences, both financially for the company and personally for its directors. Investors were also impacted directly by the controversies described in the examples; bonds have been hit hard as they reflect the increased financial risks of underlying companies.
The Robeco Credit team has been very cautious on emerging markets over the last year. Spreads have been too low compared with spreads in developed credit markets. These examples show in our opinion that emerging market credits should carry a country or corporate governance premium, even if their credit ratings are in line with developed market credits. This additional spread is the compensation we demand for running higher credit risk.
Understanding potential corporate governance issues for telecom companies operating in emerging markets is a key element in understanding the downside risk of the credit investments in these companies. This is why we have integrated ESG into our credit research process. We treat the ESG variable as one of the five building blocks that underpin our final fundamental opinion on a company’s credit. In addition, we do our own proprietary research, also on ESG. The recent issues in the telecom sector strengthen our belief in this approach.