Q&A: keener than ever on green finance

CHERIE MARRIOTT: What about Woolworths’ experience with its most recent green bond in April?

TRICIA HO-HUDSON: We had some really detailed questions from investors, not only about our green credentials but about our broad ESG principles.

The green bond was a very well-priced piece of debt and got supermarket industry media publicity and our internal stakeholders saw this.

The businesses are now actively asking how they can put a project up for green financing in order to achieve a favourable cost of funds.

ANDREW BROWN: Borrowers are generally engaging more deeply with investors, and being asked to explain aspects of their businesses they haven’t had to before. Details that weren’t relevant in the past have become relevant today.

TH-H: Yes, the detail investors are asking for is causing our businesses to think about how they make decisions and what decisions they want to prioritise.

TESSA DANN: Are investors supportive of the transition bond guidelines created by AXA? Is this the next step in the evolution of the market by bringing high emitters along on the journey or is it reducing the integrity of the market?

GEORGE BISHAY: At Pendal we rank issuers on an ESG basis within their sector. For our dedicated sustainable portfolios we can’t necessarily invest in a green bond if it is being issued by a company with a poor ESG rating.

A part of this rating asks what material risks are faced by the company and whether it is doing what it can to manage these risks.

Yes, we would invest in a transition bond but only if the company shows true commitment to change.

VICTORIA SHELTON: Pimco believes transition bonds highlight important challenges in the market and we encourage issuers in higher carbon producing industries to come to the market if they have a solid case.

Pimco’s proprietary framework already assesses issuers and green bonds on a case-by-case basis for contentious activities and sectors. In conducting our assessment, we look to the alignment of the issuer’s ESG strategy with the bond’s objectives and use of proceeds, evidence of positive outcomes and screening for possible red flags and controversies.

We are supportive of companies transitioning to a low carbon future.

GAVIN GOODHAND: We look closely at the purposes of the bond and whether it heralds a strategic change for the company or is simply window dressing. We are uncertain about transition bonds as a number of defined transition projects may not be sustainable in the long run.

BB: I am hearing investors say that their interest isn’t driven by the technology a company is employing, but rather the strategic vision of the company and whether it is serious about sustainability.

GG: That’s right. If we invest in a 10-year bond based on the promise of a transition, and then find in eight years’ time that no real advancements have been made, we are left holding a brown bond. Our end investors won’t tolerate this.

BB: Yes, but from an impact perspective, I would say there is more value in supporting a company that is transitioning from brown to green, than simply buying the bonds of a company that is already green and staying green.

Especially when the current transition bond guidelines are very specific about targeting particular assets and defining use of proceeds.

GB: Then it is a matter for investors to consider whether they want to take the risk that the transition might not occur as initially stated by the issuer.

CM: Would a tiered pricing system alleviate these issues, where transition bonds cost more to issue?

GB: Green and vanilla bonds currently price in line with each other, so issuers aren’t going to pay a premium to issue a transition bond.

What might change the scenario is if green bonds start to price tighter than the vanilla curve and in that case a transition bond may also price tighter than vanilla bonds.

There are already some instances where impact bonds are pricing tighter in the secondary market in Europe and I can see this happening in Australia too.

FA: What needs to change for green bonds to price through the vanilla curve?

GB: We need a deeper market of green-only investors. At the moment, if you want to issue $A300 million to $A500 million in green bonds you have to bring non-green investors into the book – who will only accept vanilla pricing – because there isn’t the depth in the green-only space.  Once we have critical size, the pricing might move.

KP: Offshore the markets are deeper and there have been examples where supranationals have priced through the curve. In Australia we can’t really look to the secondary market as a guide for pricing primary issuance because the bonds just don’t trade enough and the total market size remains relatively small.

As a frequent borrower we monitor the turnover in our bonds and our vanilla bonds trade at a much greater volume. While turnover is lower than mainstream bonds this is to be expected given the generally buy-and-hold nature of the majority of holders.

CM: I am interested in how issuers are identifying assets to put into their green bonds, and whether investors want asset-specific bonds or pooled bonds in which assets rotate through.

KATHARINE TAPLEY: When ANZ issues a green or SDG bond we are trying to reflect our balance sheet and therefore we are tending to pool assets. But so far we have reported on impact on a bond-by-bond basis.

That said, as we issue more of these bonds, I expect we will need to consider whether continuing to publishing separate impact reports is viable because this might become confusing for investors.

LS: If a bond is too asset-specific it becomes difficult to manage the use of proceeds. All of Investa’s properties have now been ear-marked as ‘green’, so we don’t need to ring-fence assets, but I can see how ringfencing might be needed for issuers who hold distinctly different assets, such as a water treatment plant and a rail-line.

TD: How companies conduct impact reporting is generating a lot of discussion in the market. How can issuers improve the way they communicate impacts with investors, and how do you manage investor expectations regarding reporting across the life of the bond?

KP: We haven’t published a report yet but the process is under way. We are trying to show investors the outcomes of our projects.

We have learned we need to keep it simple because it becomes a big job to gather the data needed to compile the reports and provide every single metric.

The Office of Social Impact Investment in New South Wales is leading the delivery of this report. At this stage we will be reporting impacts on a project-by-project basis, rather than aggregating the data.

SD: We expect to issue our first report in October. We are using case studies to convey general themes. Some of the templates available in the market for reporting impacts can be quite generic and hard to tailor to a particular business like ours.

We have discussed with our arranger how to compile the report. One of the surprising benefits of going through the data gathering process is finding out more about what interesting data we have, as well as what we are missing.

KT: One of the challenges is the lack of a consensus on the definition of ‘impact’. Most of us have been looking to the European Union (EU) for guidance on how our market in Australia should evolve. Can I ask the investors at the table: what is it you want issuers to measure?

GG: There is currently no consistency across the market when it comes to reporting. This makes our task of distilling the information into a sensible format to deliver to our investors very difficult.

Companies tend to be better than governments or supranationals on reporting carbon output.

VS: Pimco encourages issuers to align sustainability reporting to the Sustainable Development Goals, articulate how business strategies link to the SDGs and set quantitative targets where the greatest societal impact can be made.

A lot of our clients are looking for impact metrics across our entire fixed-income portfolio which includes government bonds and securitised assets. And there is difficulty with data beyond corporate debt.

CM: Do the issuers at the table believe there is enough information coming from asset managers about what they are looking for?

MM: We have been publishing sustainability reports annually since 2014. These reports align to various standards, frameworks, guidelines and goals, including the SDGs, GRI and TCFD.

We understand the information we provide is helpful based on feedback received from asset managers and our broader investor base. However, the more we know about what investors are looking for, the more we can tailor our reporting, even formulate initiatives designed to improve sustainability across their areas of focus.

This should, in turn, encourage greater engagement when accessing sustainable financing.

KT: Yes, and it is also Europe-centric. We are hoping that the current working group for the Australian Sustainable Finance Initiative will come up with a uniquely Australian taxonomy.

TH-H: In our experience, investors have been focused on how our green bonds are structured and they have been less interested in reporting. We would be very open to knowing what investors want as we move towards our first report in August 2020, rather than producing something that might not hit the mark.

There is a real need for standardisation in the Australian market, and maybe we can expect this to come out of the Sustainable Finance Initiative.

BB: In my mind, issuers would welcome the opportunity to integrate green reporting with other finance reports Recently AGL released its first integrated annual report that covered both our sustainability credentials and the overall finances of the business.

It’s becoming harder for companies to do one without the other, so maybe we will reach a point where we don’t need specific ‘green-only’ reports.

GB: I don’t want to trawl through 30 pages to find the data points I am interested in. Basically I am looking for a figure showing carbon emissions reduced, renewable energy generated, or waste reduced, or for a social bond, how many people have been helped and how.

LS: We have strong relationships with our investors. I believe we know what they are looking for and I know that if an asset manager was looking for some additional information we would do our best to provide this.

SD: In New Zealand the market is just developing and we have relied on research and conversations with others in the market to work out what to put into a report. I’d like to see more peer-to-peer conversations going forward, as it seems most issuers have similar challenges.

KP: I agree that holding individual conversations with investors is important. Whenever we have published something in relation to our green bond portfolio we have had some investors who focus intensely on the details and other investors who want high-level, simple figures.

Something for issuers to consider is whether they will be able to produce the same reports year after year until a bond reaches maturity.

GB: That’s true, but annual reporting is important for investors. I don’t want to be in a situation where I haven’t heard from an issuer for more than 18 months.

KT: ANZ has just produced its first SDG Bond Impact Report and it took a long time to put it together. As a bank we fund projects, we don’t build and own them ourselves, and gathering data from each of our borrowers on their specific projects was a big task.

We ran into privacy and confidentiality issues. One investor asked us to report on ANZ’s proportionate impact in a particular project but this would have required us to reveal confidential syndicate information.

This is something we will have to continue to think about and manage as we evolve our reporting.

CM: Should investors who heavily embed ESG into the investment process, or those with specific green/ESG funds, be rewarded in the allocation process for sustainable bonds?

GB: I have been disappointed in the last few green bond issues. We were asked to disclose our dark-green credentials, and yet still we got the same allocation as those investors who said they were ‘ESG inclined’.

There are only a handful of dedicated funds in Australia that are dark green, and I believe we should get 100 per cent allocation for those portfolios rather than being scaled, whilst on the other hand

I’m fine to be scaled for my non-dark-green portfolios. I don’t think issuers are considering allocation decisions closely enough.

TH-H: When Woolworths issued, we wanted to support investors with a dark-green mandate and we were clear to our JLMs that we wanted them to segment investors into different classifications.

When it came to allocation we zeroed out all the trading books and prioritised dark-green investors, so this was a significant consideration for us. One difficulty was searching for information about green-ness from investors’ websites.

LS: Investa cares very much about its investors. We would like more information about the profile of investors, how they apply screens and how separately managed accounts are handled.

MW: Investors and asset consultants have some work to do on transparency and standardisation of mandates. Investors will pay a price for not thinking hard about whether they are communicating their strategies effectively to issuers. We need to know what a profoundly green fund looks like.

CM: The sustainability linked loan has been the product of the moment, growing rapidly especially within the last year. What are your views on this product?

MM: Sydney Airport issued a $A1.4 billion sustainability linked loan in May, where we partnered with over 10 bank lenders. It represented the first syndicated SLL in Australia and largest across the Asia-Pacific.

It has been tricky for us to issue more traditional products such as green bonds and loans as we haven’t been able to identify a critical mass of green investment to fund and/or refinance.

The emergence of SLLs provided a flexible alternative to help us improve our sustainability performance without use of proceeds related restrictions. Furthermore, the ability to create a direct two-way link between our sustainability performance and funding costs added to the relative attractiveness of this product.

GB: How do you report to lenders on whether you are meeting your sustainability objectives?

MM: There are two ways to do it. You can set your own internal target, self-report and then have this verified on an annual basis. Or you can seek an external rating, which is what we did.

We are using ‘sustainalytics’ to produce a report on us which covers the entire ESG spectrum and how much are we working towards carbon neutrality. It gives an overall ESG risk rating.

GG: Could these loans eventually displace green bonds?

KT: We believe this could work in bond format especially where the proceeds are tied to general corporate purposes and linked to a particular sustainability agenda, and measured against that. I don’t believe loans will displace transition bonds – they will sit side by side.

AB: Whether companies choose a loan or a bond can be partly driven by capital structures. As for demand for this product from lenders, many banks now have targets for growing the ESG portfolio within their balance sheets, and SSLs will help them to achieve these metrics. We expect volumes in sustainable loans to swell significantly in the next few years.

This story is an edited version of a piece which originally appeared on financeasia.com