Dropping the shades

Green-bond issuance in Australia is growing, though supply remains dominated by high-grade and bank issuers. Local investors say labelled issuance is only one part of a more complex picture, which sees the Australian buy side wrestling with measuring the impact of its allocations in an environment of growing demand for ethical investment.

Helen Craig Senior Content Manager and Deputy Editor KANGANEWS

As the global push toward socially responsible investment (SRI) has gathered steam, so has the size of the green-bond market. According to Climate Bonds Initiative (CBI) data, global green-bond issuance reached US$108.3 billion in 2018 to the end of the third quarter. Australia’s market has developed from humble beginnings in 2014 to one that delivered more than A$5.5 billion (US$3.9 billion) of new issuance in 2018.

In many jurisdictions – notably Europe, the acknowledged market leader in green-bond development – the driver of supply has been exponential growth of funds actively seeking labelled issuance, often supported by government action. This liquidity pool is now big enough to help draw issuers to the labelled sector.

Australia’s private sector, meanwhile, has been forced to step in where government is absent. On the institutional-funds side, different methods of environmental, social and governance (ESG) assessments have evolved over time.

One question that often arises following green-bond transactions in Australia is whether a domestic “dark-green” funds market is evolving. So far, this market segment has been nascent in Australia at best. For instance, lead managers on New South Wales Treasury Corporation (TCorp)’s A$1.8 billion green-bond debut in November 2018 say just 11 per cent of the bonds were distributed to dark-green investors and a further 41 per cent to “light-green” accounts. The balance went to standard fixed-income funds.

“Unless we are so steered by our client, we can’t suddenly decide we want to ‘do good’ and buy a low-yielding green bond. However, we can choose to be supportive by buying a green tranche where a transaction has a green and a nongreen option and the two are economically equivalent.”

Full integration

However, the debate about dark and light green funds may prove to be moot. For one thing, there is not yet an agreed delineation of the difference between the two. A plurality of market participants define dark-green funds as those deploying positive screening processes – in other words, requiring proof of positive ESG impact – while light-green investment strategies negatively screen to exclude sectors with poor ESG profiles. However, others simply classify dark and light green on a linear scale of the intensity or depth of ESG processes.

Perhaps more importantly, Australian investors increasingly report that ESG assessments are present in every credit view they take and not just those for green bonds. They say integrating ESG practices more holistically within investment strategies enables them to get a better grasp on associated risks.

Investors say defining funds or bonds as dark or light green is something of a sideshow. “We’ve observed development around definitions of light and dark green bonds and we are supportive of these, but they have never really been a motivation for us,” says Bill Hartnett, head of responsible investment at Local Government Super in Sydney. “What we want is good investment outcomes. Our funds are performing very strongly – and the managers with better ESG capabilities are the strongest contributors and outperformers.”

Institutional funds with strong ESG views are emerging from the margins thanks to client demand. Rachel White, Melbourne-based product strategy manager at Vanguard Investments Australia, says her firm has seen ESG gain significant interest at the institutional, intermediary and individual level, with three key drivers.

“Three in four millennials in Australia say they would prefer to invest in a responsible investment or super fund rather than one that purely aims to maximise investment returns.”

First, she mentions investment preferences, as an increasingly diverse set of investors seek to express value from their investments alongside a financial return. “In particular, we are seeing strong demand for ESG from female investors and from the younger generation. Three in four millennials in Australia say they would prefer to invest in a responsible investment or super fund rather than one that purely aims to maximise investment returns,” White tells KangaNews.

Next, she points out that the environment is becoming more conducive for ESG investing. Specifically, the regulatory environment is developing in such a way as to facilitate ESG disclosures. “We are seeing greater transparency in standardisation of ESG data and reporting and, with more products and indices available, investors have greater choice.”

Finally, the weight of research supporting the hypothesis that ESG investments have a neutral-to-positive impact on company performance is growing. “We are seeing a real shift from the long-held view that ESG investing underperforms,” White says.

In addition to end-investor demand, Matthew Moore, Sydney-based head of ethical investments at Uniting Financial Services (UFS), argues that increasing focus on ESG is also coming from a growing acceptance that the fiduciary duty of institutional investors includes a requirement to understand all risks – including in the ESG space. “This is evident in some of the regulatory regimes in Europe and what’s in the pipeline in the UK and China,” he tells KangaNews.

Work of this type is clearly less progressed in Australia. But Moore highlights comments from the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission about the importance of understanding balance-sheet risk in the transition to a low-carbon economy.

Investors seeking green roots in support of green issuance

Australian investors are largely comfortable with the integrity of reporting on green bonds. They are, however, paying close attention to the wider context of assets being funded by green issuance – and are not prepared to take any label purely at face value.

New South Wales Treasury Corporation (TCorp), which issued a A$1.8 billion (US$1.3 billion) green bond in November 2018, provides a perfect case study. The TCorp deal includes funding for public-transport projects, and investors are happy to ascribe positive environmental value to developments that should reduce car usage.

But coal-fired power still generates much of the electricity that powers trains in New South Wales (NSW). This is beyond the scope of the green-bond issuing entity or even its wider remit. Investors say this is where opacity around the greenness of assets creates a stumbling block.

Client alignment

However, some investors caution that it important for asset managers not to get ahead of their clients even as the appeal of ESG investing grows. “It is not our job to make an ethical call on clients’ investments,” explains Nick Bishop, head of Australian fixed income at Aberdeen Standard Investments (ASI) in Sydney. “We are here to service clients’ needs. If we can leverage our technology to help clients achieve an outcome that is important to them, and we are instructed to do so, we can deploy that technology accordingly.”

John Sorrell, head of credit at Nikko Asset Management in Sydney, agrees that the asset manager’s job is to execute rather than drive ESG preferences. “Unless we are so steered by our client, we can’t decide we want to ‘do good’ and buy a low-yielding green bond,” he points out. “However, we can choose to be supportive by buying a green tranche where a transaction has a green and a nongreen option and the two are economically equivalent.”

It is a balancing act, Hartnett admits. Local Government Super puts the risk-return equation top of its priority list, and only after this will the firm shift its focus to investments with positive environmental impact.

These norms are well established. The change some investors report is the emergence of real growth in the quantity and scale of requests from end investors to incorporate or otherwise account for investment impact.

White tells KangaNews: “When we examine investment behaviours, particularly in the newer cohorts like millennials and females, we find ethical and performance aspects are considered equally important. For these investors, expressing views and having social utility and a feel-good factor are at times just as important as maximising investment outcomes.”

The evidence lies in the growing prominence of mandates with an explicit ESG component (see box). For instance, in 2018 Local Government Super awarded a new fixed-income ESG mandate to PIMCO, Vanguard Australia launched a range of new ESG bond and equities funds, and ASI announced a partnership with Australian National University to manage an Australian fixed-income strategy with an emphasis on ESG.

If these new mandates are a clear indication of the direction of impact investing in Australia across the buy side, the future will see integrated approaches enabling institutions to offer bespoke solutions that meet individual needs.

ESG in the mandate process

Australia is experiencing growing prevalence of environmental, social and governance (ESG) aspects to the funds-management mandate process. Investors say winning such mandates cannot just be a matter of responding to clients’ requirements on a case-by-case basis but demands a strong holistic approach.

For instance, Australian National University’s endowment fund has selected Aberdeen Standard Investments (ASI) to manage an Australian fixed-income strategy with an ESG overlay. This fund will “facilitate the negative screening of securities issued by any company that derives in excess of 20 per cent of its revenue directly from tobacco, coal, gambling or adult entertainment.”

Nick Bishop, ASI’s head of Australian fixed income, says impact investing has been an increasingly important consideration for ASI especially since the merger of Aberdeen Asset Management with Standard Life created the new entity in 2017.


Fixed-income managers are beginning to integrate ESG much deeper into their processes. They can bring in ESG scores and ratings, combine these with their credit views and fundamental approaches to investing, and develop their own ratings around material factors.

Impact toolkit

With end-user demand for ESG considerations set to play a bigger role in funds management, Australian fixed-income managers are keen to have access to reliable and consistent data. Some say its availability is a hurdle to improving investment approaches that are striving to incorporate ESG analysis outside the narrow world of labelled issuance that reliably comes with issuer and third-party reporting.

Sorrell says: “The challenge we face is that many corporate issuers are not covered by the research provided by the likes of MSCI and Sustainalytics. Basically, if it’s not a listed company we have to do considerable internal research to assess the risks and identify the relevant themes.”

In fact, Bishop suggests that only around a third of the issuer base underlying the Australian Composite Bond Index is covered by MSCI or Sustainalytics research.

The need for comprehensive and comparable reporting data is only made more intense as investors grapple with the second- and third-order impact of their allocations (see box).

The UN Sustainable Development Goals (SDGs) help. Moore says UFS scores its portfolios using a negative and a positive approach, with an investment policy based on 14 principles that have been mapped very closely to the SDGs. “Our own principles enable us to tag our investments to the SDGs, which are now being recognised as a universal language,” he explains.

“We should be able to offer our customers semi-customised, or at least modular, ESG screening that enables them to invest socially and responsibly.”

Integrated company sustainability and annual reporting would be welcome. “The Sustainability Accounting Standards Board Foundation standards and the global reporting initiative bring to the surface sustainability topics that are reasonably likely materially to affect the financial condition or operating performance of companies,” Moore says. “The standards enable companies to disclose comparable information so investors can benchmark performance on the issues that matter.”

Integrated reporting also demonstrates that companies are embedding ESG principles in their DNA, Sorrell adds. “The trouble with separate reporting is the sustainability portion can sometimes appear to be a bit of an afterthought.”

Buy-side sources say that, for the time being, their aim is to build a framework to provide a repeatable way of assessing the factors end investors care about. Their goal is to provide clients with investment approaches that match their own values.

Bishop explains: “We are pushing to ensure we have a scaleable, industrialised approach to screening. The end goal is for the client to be able to say that of, for example, 30 factors they want to be able to control for they have sensitivities around seven and they want to set a revenue hurdle of 15 per cent. If we get this right, we should be able to offer our customers semi-customised, or at least modular, ESG screening that enables them to invest socially and responsibly.”