ESG debt in Australia: progress report
In November 2018, KangaNews brought together experts in sustainable debt from each of Australia’s big-four banks to discuss the state of the local market and its growth prospects in the year ahead. Participants acknowledge that development has not been exponential so far but point to a vast quantity of work going on behind the scenes and the challenges involved with changing attitudes, working without reliable political guidance and establishing market infrastructure.
Davison It is about four years since green bonds were introduced in Australia. How would you grade the evolution of the market?
We have also sought to bring product innovation. Although we haven’t issued a senior green bond in the domestic market for a while, we have issued in Europe and the US in 2018. The US is not quite as developed as Europe but we want to show leadership and try to help grow markets.
Even though we have not issued a senior green bond in Australia since our inaugural deal we issued a green residential mortgage-backed securities (RMBS) transaction in 2018. We also issued a low-carbon shared portfolio. We have been present in the Australian market, in other words – just not in senior format.
We are focused on areas outside of green as well. In 2017 we issued a social bond focused on gender equality. This sector is developing, perhaps at a slower pace than we would like, but we are trying to do the best we can with limited resources.
The whole area of green and social finance is being driven by corporations and private entities as opposed to being promoted by government policy or regulation.
Europe has been the leader in this space and it is where the green investors are most highly concentrated. The pace of development also feels fastest in Europe and it is not lost on us that our peers have been issuing into this market.
The other thing I would mention is that when Commonwealth Bank of Australia (CommBank) began looking at this space the focus was on what was required for us to issue a green bond. There has been a lot of foundational work done since we started reporting on sustainability a couple of years ago, including incorporating sustainability and environmental elements into the group’s strategy, developing environment policy, redefining how we lend, invest and procure, and all the way to taking a position on human rights.
Today, sustainable business practice is an integral part of the way we do things, and an essential component of our annual report. It has full sponsorship from our board and executive leadership team. In 2018, we were named Australia’s most sustainable business for the third consecutive year.
We are also thinking about sustainability much more broadly across the group, and our clients and portfolio, rather than just about our emissions. This also aligns with how investors are developing their thinking. As investors screen us across ESG [environmental, social and governance] factors, this influences whether they will invest in our bonds.
We certainly see bigger drivers in some offshore markets compared with the domestic market, and this is likely to see us diversify our issuance internationally. US dollars is certainly on Westpac Banking Corporation (Westpac)’s agenda over the next 12 months as we continue to show our capability in different markets.
Europe has the benefit of a partnership between government and corporations. Europe is pushing forward with legislation that brings tangible and identifiable investment behaviours into force. This drives direct access to the market and encourages dialogue with investors around sustainability. From an issuer’s perspective, this makes it easier to consider the European market and its value.
In Australia, we certainly want to do more but we need to prioritise. Ultimately, there is limited capacity. There are a lot of passionate people in different organisations driving the agenda, but with limited resources. We all need to pick and choose where we want to go and where we allocate resources on an annual basis.
If we could do more of our issuance in UN sustainable development goal (SDG) or green format, we would. But we have a finite pool of assets, and the reporting and governance pieces still need to be up to the appropriate standards. Having more dialogue like we are having today, including with investors, is certainly important to push the agenda forward.
Going forward, we would like to be in these markets at least once per year. We are driven by demand and we have no reason not to come to the domestic market, but it will depend on where demand is at the time.
I agree with Alex Bischoff on sophistication and the need to move forward with reporting. One of the challenges we face is reporting effectively on impact. Some of the things for bank issuers to overcome include access to information given we are the lender to, not the owner of, the underlying assets, and the nature of meaningful metrics particularly around social issues – given these are still being worked through by issuers and investors.
The level of care and attention required to be absolutely sure we will meet requirements on an ongoing basis is that bit higher than in other forms of funding.
Reputationally, not getting it right can have big consequences. But this is an area where investor requirements are moving at quite a pace. They too have developed significantly from where they were four years ago.
Local and global standards
Green-bond markets in global jurisdictions are moving towards formally established taxonomies or definitional regimes. Australian market participants recognise the value of harmonisation but still have some doubts.
FOX Our sense is that Australia shouldn’t run off and do its own thing. There should be some harmonisation.
BLACKSTOCK A taxonomy is being provided already by some of the global players that provide certification.
KENNA I think rather than having an Australian taxonomy it would be more beneficial for the market to focus on some channelled initiatives to get scale. One of the problems locally is that we divide our focus when we have a relatively limited amount to work with. This can make it difficult to achieve anything meaningful.
As a group, if we can get behind a few specific initiatives I think we could foster more meaningful evolution and create impact and scale which market participants can get behind.
White What are reporting schedules like for the bonds the other banks already have on issue?
Davison Are the major banks providing sustainability reporting as part of the annual reporting cycle, as an integrated report or a separate sustainability report?
This is an evolution. Although our full-year report, that goes to equity investors, contains a section on ESG it only really became part of our debt roadshows in 2017.
Integrated reporting is something the group is working towards. From a treasury perspective, ESG disclosure is a key development focus. When we did our euro transaction, the traction and engagement we gained with investors by having a specific and targeted ‘green’ presentation was tangibly different from any experience we’d had before. It was a real eye-opener, though it also took a lot of work.
In a market as developed and mature as Europe, this was a real value add for us. It also triggered a change in behaviour around how we think about the ESG section of our fixed-income presentations going forward. The feedback we get is that investors want to see more of this, as ESG increasingly becomes a part of their overall credit assessment.
When we talk about impact reporting it is true that, as Eva Zileli says, certain areas are better defined – for instance around carbon impact – and so are certain types of products. It is constantly evolving.
The good thing about the industry at the moment is that this feedback isn’t criticism – it is constructive and helps us build on what we are doing.
Swiss Are the reports that are part of your debt-investor roadshows focused on specific bonds or the broader sustainability of the bank?
Similarly in the impact report, what investors see is what they want to know: broader climate-change performance and sustainability strategy. They see things like how we fund renewables and how we see this market evolving. We are telling a much broader story.
Swiss All this reporting must take a lot of resources. Are issuers seeing any primary-market ‘reward’ in pricing?
I liken it to the Securities and Exchange Commission (SEC) registration Westpac has in the US. This opens our programme up to a section of the market in the US which cannot buy non-SEC-registered deals.
The value of going to a market like Europe with a green label is that it engages a type of investor that has targets on ESG assets. Final pricing outcome is a tangible output of this engagement. Whether it means tighter pricing by 1 or 2 basis points is hard to tell, because it might not have been the same deal without the green label on it.
The sustainability aspect certainly helps execution and it probably helps secondary-market performance as well, which helps the curve. There are other ancillary benefits which we might not see so obviously in primary markets.
I think the distinction between ‘dark’ and ‘light’ green investors might be losing momentum because more and more investors are looking at ESG more broadly. As an issuer, it’s important to screen well for ESG regardless of whether you are talking to light or dark green investors.
We have observed that investors – whether in CommBank or in other names – value the ability to buy something that has rigour around it and is certifiably green or social in nature. They use this to meet their own corporate objectives and also to engage with the customers they market to.
The Australian Prudential Regulation Authority (APRA) made its first official pronouncement on a potential Australian equivalent of total loss-absorbing capacity (TLAC) rules in November 2018. Local market participants are still assessing the potential consequences.
KENNA An area of sustainable finance that is small but I think is interesting is SIBs. There are a number of these projects in the market at the moment, though they are small in scale – which means this segment does not always get the attention it perhaps deserves. It can also be quite labour intensive.
But, at the same time, SIBs offer genuine impact. SIBs like The Benevolent Society’s are tangible and readily understandable things people can connect to and see that they’ve made a difference.
Investors have skin in the game and there are some that want to be able to say they are investing in something which otherwise would not have occurred and delivers a social outcome – which might be one they can relate to specifically.
KENNA The reality is that it is a very different investor set. It isn’t the typical institutional investor, although there are many that are actually keen to see more of the product because of their mandates and investment directives. It can resonate more with high-net-worth individuals and family offices, though.
FOX We have done some SIBs including some private deals, and I agree with these points. It is a smaller universe and it is also challenging.
We have done some work in recidivism, but the projects are often small scale. The delivery of outcomes is often a long way off and quite uncertain. But market participants are working on these projects in the background and eventually the sector will become larger in scale.
There is great opportunity in areas like housing affordability where we probably just haven’t cracked it in the right way yet.
KENNA People in the business and the community can really connect to these issues. With issues like affordable housing you are actually solving a genuine community problem that people can relate to.
Davison Corporate green-bond issuance has been very quiet in Australia. Is this picture disappointing or is it not surprising given corporates in Australia have very little capex and thus limited funding tasks?
Like banks, corporates are very focused on cost and there are a couple of points which relate to the lack of green issuance. One is integrating this into corporate thinking at C-suite level and within the treasury operation. There is additional cost for green issuance – it isn’t massive at the point of issuance but is more about the ongoing cost of reporting and ensuring the integrity of the programme.
This influences a lot of treasurers’ mindsets insofar as they don’t have massive capital-raising tasks and there is still good interest in mainstream corporate deals due to undersupply.
Swiss Is it fair to say there is still some cynicism from corporates on the real value of green-bond issuance?
Having said this, I think corporates are very aware and are watching. If there was an identifiable price advantage they would probably react more readily. I use these words specifically because the debate around whether there is price advantage in bond issuance is very hard to resolve. It is a different story in loan format, where there might be an explicit price incentive.
We speak to treasurers who previously said there would have to be a price advantage for green bonds but are now linking the conversation to a corporate-sustainability agenda which they want to be a part of.
Swiss Is there any obvious distinction between companies that have sustainability officers integrated into treasury and those that don’t?
Davison Could green loans have a role here? The point has been made that many corporates are moving on from wanting to see an explicit price advantage from green-bond issuance, but equally a green loan with differential pricing surely couldn’t hurt.
I would argue that if an asset comes to the market with a green or sustainability flavour, it would definitely attract a more aggressive and deeper pool of capital. As a result, these loans often get better pricing and more competitive terms. Over time, I think we will probably see this move through into capital markets as well.
This is where ESG-linked loans are an interesting development – because loan pricing is linked to sustainability performance. The lender thus has skin in the game and the borrower also has an incentive to improve. This is definitely happening in Europe and it is beginning in Asia as well.
This has gathered pace in the last 12 months with the green-loan principles, and I agree that we will see more of this in Australia. For some corporates, where perhaps green-bond issuance hasn’t been the way for them to go, the green loans or ESG sustainability-linked loans will be a way for them to move into this type of financing.
Davison If Australia developed a green-loan market would it provide more natural assets for bank green bonds?
ESG sustainability-linked future targets also bring motivation to an organisation. The motivation is often already there but having a pricing benefit linked to targets creates extra momentum.
Interestingly, in France they are modelling customer rating systems (eCRS) to give credit to sustainability, which goes to the point of integrating sustainability into organisations.
We are not incentivised in a pure regulatory capital sense in Australia, but Rob Kenna touched on an interesting point about being incentivised through our own eCRS or credit risk assessment on a particular organisation. We could therefore be prepared to lend more or add some other element into a financing decision.
This came about because we have been receiving feedback from parts of the market with green mandates or fossil-fuel-exclusion screens – like local government and nonprofits – that want to invest their capital beyond green bonds.
This covers a range of different things, for instance PPAs [power purchase agreements]. We were involved in the first IPO for a solar farm, with New Energy Solar, and we are looking at other things like this in the equity capital markets.
The green RMBS deal NAB did was really trying to help the development of the securitisation market, the way its participants think about sustainability and what may be available to them.
The low-carbon shared portfolio was another way to give access to a type of financing which would otherwise be done on our balance sheet. There is also an element here of being able to recycle capital to facilitate more of this lending and therefore further develop the market.
This also means, as a treasury and in the capital markets area, that we are working to support these goals because our issuance counts toward this target.
We are completely integrated from the very top to treasury, which enables treasury to support the firm’s corporate-responsibility agenda. Nowadays, we are able to connect with the organisation more broadly and the people working on sustainability are very involved. They feel engaged and proud that NAB is working towards supporting a low-carbon economy and social objectives, irrespective of government policy.
The policy element would help accelerate progress, though. We are doing very well as a country despite this, but we won’t get to the targets that have been set – including the achievement of the SDGs by 2030 – without some policy direction and guidance.
Davison We have seen some commentary from the Australian Prudential Regulation Authority, going back a couple of years, around the relationship between long-term climate risk and systemic risk, so there is clearly some thinking going on there.
The US is driven on a state-by-state basis and I wonder if Australia will be pushed along because we are major trade partners with China and we issue a significant amount of bonds into Europe. The momentum in these regions could ultimately help Australia.
Australian market participants see reasons for optimism about the evolution of local sustainable capital markets. They are looking for a range of developments in 2019.
CHEN I think some of the things we have touched on will be more developed in 12 months’ time. We have talked about loans, and I think we will have seen the first environmental, social and governance-linked loan in the Australian and New Zealand market by the end of 2019. I don’t think the conversation around taxonomies will go away. There are a lot of different views around the table today and I think the conversation will continue.
Swiss Are you saying even corporates that view sustainable finance as a PR exercise shouldn’t dismiss it just for that reason?
Swiss Is it fair to say banks are leading the Australian corporate universe on reporting?
Davison We’ve alluded to the buy side several times, including how we might think differently about dark and light green. What is the level of engagement from Australian debt investors on ESG and how might it develop?
These investors will buy green bonds but they will also buy vanilla on the basis of a look-through to the broader sustainability targets and credentials of the issuer.
Davison Is this preference a bit like with ratings, where fund managers will always do their own credit analysis but also obviously prefer externally rated to unrated issuance?
But we have to be realistic. I recently met with several domestic debt investors and I didn’t receive a single question on ESG. Investors may be working in the background to integrate ESG into their credit analysis, but when we see them face-to-face the questions don’t come through on the sustainability agenda, green bonds and targets that are included in our full-year investor report for debt investors. I wonder if this demonstrates that we are still a bit behind Europe.