Longform Q&A: access & incentives as green goes mainstream

NIGEL GREENWOOD: Our sustainability goals cover three pillars: the environment, enterprise and people. Environmental goals tend to be the main external focus but we look at it from these three perspectives.

The goals that pertain to the pillars include targets for reducing greenhouse gases and water use, improving the representation of women in the workforce and leadership, and building reputational currency through better food safety and transparency standards.

BLÁTHNAID BYRNE: AGL Energy has maintained its strategy on carbon emissions and having these aligned to a sub-2-degree future. There were questions as to whether this would change with leadership transition but the new chief executive, Brett Redman, has reaffirmed the commitment.

We look at this through the lens of decarbonisation but also of ensuring energy supply continues to be reliable and affordable. It is a ‘trilemma’ that we need to manage – we are walking a tightrope between sustainability, energy security and affordability.

This focus is why we shifted to an integrated reporting format this year. Our sustainability team also sits within the capital markets team, which reflects our view that the team needs to be immersed in the goals and outcomes of AGL’s sustainability measures in order to have meaningful conversations with our debt and equity investors.

MATT ZAUNMAYR: To what extent do issuers’ goals need to tie in with debt funding? In this context, what is the potential scale of financing based on holistic scoring of sustainability performance, such as SLLs versus the use-of-proceeds funding we see in, for instance, the green bond market?

NG: I don’t think our sustainability goals are directly linked to our capital-markets funding requirements. In other words, to achieve the goals we do not necessarily need to seek incremental capital markets funding – whether it be debt or equity.

We did not require the funding to achieve our sustainability goals for our recent ESG risk-weighted loan. Rather, the loan is an appropriate size and links to our purpose statement and who we are as a company as well as the measures we are taking to improve our ESG reporting.

BB: A few financing products are suitable for AGL and those are ones not linked to use of proceeds – at least for on balance sheet funding. Off-balance-sheet investments could be funded with a use-of-proceeds product.

Renewable energy is a good example of this. We have a 20 per cent equity stake in an Australian renewables fund set up with QIC and The Future Fund. It is a decision point for every project whether we have it on balance sheet, sell it into the fund or do an entirely different form of financing altogether.

Given the nature of the company, for on-balance-sheet funding it is important that we are proactive in linking funding to ESG performance.

While this is nice to do today, it isn’t necessary. The hope is, in future, banks will require the type of thinking from all borrowers and customers that makes them comfortable where their money is going respects the challenges coming and is prudent in managing and mitigating climate-change risks.

MM: The potential scale of financing based on holistic scoring of sustainability performance is massive. We are an issuer that is not currently suited to use-of-proceeds sustainable finance given we lack a critical mass of green investment to fund or refinance. The emergence of SLLs provides an opportunity to engage in this space.

This very much seems to be the case for many other issuers that have reached out to us following our SLL transaction. Aside from the flexibility of holistic scoring, it is worth noting products such as SLLs offer other unique benefits such as the potential for a direct and transparent pricing discount or penalty.

We will, however, continue to investigate ways in which we can issue use-of-proceeds-based sustainable funding, especially in the context of our balance sheet being primarily comprised of long-dated bonds.

Interestingly, more than one in five of the questions asked on our most recent bond investor update through Europe were related to ESG or ESG funding. It is a clear area of increasing interest among our investor base.

KATHARINE TAPLEY: Having access to sustainable finance through capital markets has become very important for ANZ as an issuer. We issued our first green bond in 2015 and followed this in early 2018 with a UN Sustainable Development Goal (SDG)-linked bond.

When our treasury team is on a debt-investor roadshow, we now find there are questions around what we are using funding for to shift the nature of our balance sheet.

There is a push from the investor base; there is a pull from the client base as well. The connectivity between the funding we raise in capital markets, with an ESG overlay, and how we deliver to our client base is very important.

MZ: The link between sustainability and long-term shareholder value seems clear. But does the same apply on the debt side? Does it fundamentally matter if the debt market comes along for the ride?

KT: Debt is about 80 per cent to 90 per cent of the capital stack. We cannot achieve a sustainable economy globally without debt being central to the picture.

MM: Whether or not the debt market comes along for the ride, the ability under an SLL potentially to benefit from a pricing discount or suffer a pricing penalty uniquely drives behavioural change.

It does so by incentivising issuers to accelerate the delivery of sustainability initiatives and formulate new ones, while ensuring sustainability performance does not deteriorate. This behavioural change has brought sustainability to the fore across our leadership team.

GAVIN CHAPPELL: This is why, over time and when the market gets to the point where most companies are doing it, it is those that don’t that will be penalised – in pricing and in the availability of capital.

LI: A lot of corporates are exploring areas of sustainability that they hadn’t previously. This can be in the supply chain, waste or many other things.

KT: I agree, and I think we will find that consumers will continue rapidly to educate corporates. There has been a lot of research and writing recently on millennials and generation Z coming to acquire most of the world’s wealth within the next five to 15 years.

This is driving significant change at the real economy level because consumers are becoming more discerning on where their food and clothes come from, how waste is managed and where their superannuation is managed.

Necessary growth

MZ: Europe is clearly leading the way in sustainable finance. But even in Europe there is a sense that the market needs to grow exponentially if it is to have any hope of achieving global goals outlined by the Paris Agreement and the SDGs.

Central to this growth will have to be progress beyond use of proceeds as the basis for financing. How clearly does this message resonate with Australian issuers and investors?

NG: Market leadership is certainly coming from Europe. The process of developing our ESG loan started in June last year when our board went to Europe to meet some of our major partners there, such as Danone and DSM.

They told us about their recent ESG risk-weighted loans and this sparked our interest. They showed us how the product worked and the incremental pricing benefit they received based on their risk weighting improving.

Once back in New Zealand we enquired with ANZ about these loans and it began guiding us through the process. ANZ was impressed with our recently announced sustainability goals and thought we would be a good candidate for this type of financing.

I would also like to stress that our loan was not an SLL. It is an ESG risk-weighted loan so it has focus across environmental, social and governance reporting requirements.

GC: The emergence of SLLs has generated more interest than we have ever seen in the loan market. Sustainability is on the mind of almost every corporate we speak to.

The SLL angle has created a huge amount of interest because companies can demonstrate their sustainability objectives without being so focused on the use-of-proceeds angle. We expect this to be the fastest-growing part of the market, by a large margin, over the next few years.

SLLs are suitable for any company that has a sustainability agenda, whereas a green loan or a use-of-proceeds type of financing is not necessarily suitable for everyone.

NG: This is the beauty of the format. With a green bond the expectation is that the funds be used specifically for capital expenditure with an environmental focus. The ESG risk weighted loan is part of our standard revolver financing. It is far more effective for a business such as Synlait.

MW: SLLs should also bring along ‘browner’ companies because they offer an incentive to transform.

This is where more impact can be achieved than with companies that would have assets to go into a green bond – those that are already on the journey. Funding for transition is going to have a lot more impact than a green bond would.

BB: It is important to have the incentive of a lower cost of borrowing. But at the same time there needs to be a penalty as well. Otherwise a company can just stand still and nothing changes.

GC: A number of CFOs we have spoken to on SLLs have said the product is of interest because it provides an incentive to bring the whole organisation along on the sustainability journey.

When it comes to capital-investment decisions, the CFO can demonstrate the cost of capital being directly affected by increasing sustainability. This incentive is of benefit to all users of capital within an organisation.

MM: It is important to understand sustainability extends beyond investment. Many issuers, including ourselves, have been sitting on the sidelines for many years while green bonds and loans were flourishing.

Equally, sustainability performance improvement can be incremental, diverse, and delivered over time by any issuer with an ESG focus – even those transitioning from being large carbon emitters.

While improvements must be meaningful, they need not be delivered via one or two blockbuster initiatives and need not only focus on any one of ‘E’, ‘S’ or ‘G’.

Governance is relevant to all issuers, is critical to corporate sustainability and is a great area to focus on. But this element is at times overlooked, sitting in the shadows of more topical and tangible environmental or social initiatives.

MZ: We should get a view from lenders on the value of offering a sustainability incentive in loan facilities. But first let’s hear about investors’ overall ESG drivers.

GRAHAM MCNAMARA: We are a nonbank lender and an alternative asset manager. We are the largest nonbank corporate lender in Australia with around $A5 billion in assets under management.

ESG is very important at the wholesale end of our investor base. These clients don’t give us targets but they do give us a clear indication of what they like and don’t like.

We are required to complete ESG surveys every year for many investors. At this stage their ESG targets are largely broad-based.

We don’t have any explicit exclusions although there are some areas we don’t look at. We have heard from a number of investors that they have restrictions on investing in any carbon-related industries.

As a lender it is very difficult to separate ESG from credit risk. A company or a borrower that has a bad ESG track record will undoubtedly end up being a bad credit risk. This is the way we look at it and it is a big part of our investment process. We have declined a number of transactions because of ESG-related issues with a borrower.

MW: ESG is certainly growing as a risk-return driver. As fixed-income investors we have always thought a lot about governance risk. There have been idiosyncratic issues where an environmental or social issue has affected the price of a bond.

We have had a range of exclusions for a number of years, similar to what Graham outlined. We also have a range of clients that are at different stages of their ESG journeys. Some clients are very advanced, particularly those in the insurance industry.

The range of exclusions and reporting requirements we are being asked to do is interesting and aligns with a lot of the work we are doing in thinking about risk in portfolios. For instance, some clients won’t fund energy companies that don’t have a transition plan which meets the company’s national Paris Agreement commitments.

We are fixed-income, predominantly vanilla-bond investors so our central interest is in default risk. In other words, we are downside risk managers. If we get some upside that is great, but this is not equity. We look for issues beyond financial metrics that could affect the price of bonds or the ability of an organisation to repay.

CT: The more transparent a borrower becomes the more it affects investor appetite. This brings increasing complexity and linkage. A lot of companies are looking at ethical supply chains. This is an interesting feature of the market which will continue to morph.

Banks will need to become quite clear in what they do and don’t do as well as why they are doing it – and be clear on how they are influencing transition and why.

MW: Blanket exclusions are dangerous, though. Some investment boards won’t invest in coal, but this opens up a discussion as to whether you can invest in bank equity if the bank is making revenue from funding coal. Going down this route does not support any sort of transition.

You can read part two of the discussion soon on ANZ Institutional

This story is an edited version of a panel discussion which originally appeared in KangaNews