Debt capital market developments and trends in the SRI space
KangaNews speaks to a range of representatives from Australia’s big-four banks about the role of capital markets in financing global sustainability initiatives, developments in the fixed-income socially responsible investment (SRI) space, the challenges to growth of the impact bond market, and what tops their wish list of things to happen to promote further market growth.
CAPITAL MARKETS' ROLE
Swiss Can capital markets step up and play a direct role in the development of the SRI market globally, for example by funding projects that help meet the United Nations (UN)’s Sustainable Development Goals (SDGs)? Is this role one of the reasons Australia’s banks have made such a strong commitment to sustainable finance?
These are definitely among the drivers behind our commitment to sustainable finance. Now that the SDGs are emerging as a potential financing platform, much like the Paris Agreement, we are actively engaging in conversation in this regard. For example, we participated in SDG financing forums during UN General Assembly week in New York in September this year.
Second, resulting from a conversation with PIMCO – one of our key fixed-income investors – we have recently mapped our project-finance book to the SDGs. This shows we have a few billion dollars-worth of assets that match to climate action, clean water, liveable communities, affordable energy, and so on.
Ultimately, however, the capital-markets piece is driven by supply and demand. If there is demand, supply will follow. We can’t create and force SRI product in a vacuum. Having said this, we are seeing growing demand for SRI products. This reflects that investors are being pushed by their clients and shareholders to invest in SRI product.
Westpac Institutional Bank (WIB)’s strategy, from a capital-markets perspective, is that when we see a need and demand growing we want to address it by providing the products that will be a catalyst to that need.
It’s the same when you look at social-benefit bonds (SBBs). With SBBs, the capital markets have found a way to structure deals that offer investors good returns for the risks they are taking on but that are also delivering positive social outcomes. Governments only pay according to the social impact generated. It’s a real win-win-win.
Deal highlights: Westpac Institutional Bank
Although Westpac Institutional Bank has worked on big transactions in the socially responsible investment (SRI) arena, the deal the team is most proud of is the social-benefit bond (SBB) for The Benevolent Society of New South Wales (BenSoc).
GODDARD Of course I’m very proud of Westpac Banking Corporation’s own green-bond deal. Also, World Bank’s green-bond deal in the Australian market. The deal helped develop the green-bond space – as the first deal of its kind in the domestic market, the World Bank trade provided a benchmark for green product. Prior to this all green product had been issued offshore.
Bringing the World Bank deal allowed investors to see how the World Bank green bond was positioned relative to the existing World Bank Kangaroo curve in Australia as well as relative to World Bank’s green bonds issued offshore.
But I’m probably most proud about what our structured-finance team and other colleagues did to bring the SBB to market for BenSoc. This is the hardest type of transaction to bring due to the education required for investors. It’s not as vanilla a product as a green bond, and this makes the process more challenging. However, the reason it also resonates is that it has a much more direct social impact. Seeing a capital-markets instrument have a direct positive impact on foster care is a great outcome.
CHEN I agree – especially if you look at what BenSoc has achieved over the past four years. Since its inception, the programme has an 89 per cent preservation rate for families referred to it. This makes the programme among the strongest-performing intensive family-preservation services in the world. By meeting the performance KPIs, it also generates financial returns for investors – 7 per cent for capital-protected class investors and 15 per cent for capital-exposed class investors.
STRATEGIC PURPOSE
Swiss Do you see the development of the SRI market as a strategic goal for your team, and how does it fit with other priorities?
Westpac has set clear goals to ensure its own sustainability and to maximise the sustainable contribution the bank makes to local and global economies. Capital markets have a role to play in all this, but the capital markets are not informing the group’s strategy – it is much bigger and broader.
Having said this, the fact that we have a head of sustainability in WIB shows we are doing a lot in this space across our institutional-banking platform. It’s not limited to what we are doing in capital markets – there is an SRI overlay on everything we do.
Green and sustainability bonds specifically are emerging as one of the key financing tools, hence the strategic focus we are putting on this within sustainable finance and jointly with our capital-markets team.
One of the key strategies for ANZ is around the capital flows across the Asia-Pacific region as a whole. If you look at what has happened around sustainable finance in the last 18 months, particularly in China, this has clearly been the big driver of growth.
Of course we see the Australian market as important but we have also been actively involved in the development of the New Zealand market. We joint-led the first green Kauri bond from International Finance Corporation (IFC) earlier this year and we also worked with Contact Energy when it converted its entire MTN programme into a green one. In Asia, too, we have done a number of transactions for the likes of Castle Peak Power in Hong Kong and Rural Electrification Corporation in India.
We are involved in the SRI space because our clients are, and our business is client-led. The demand side of the equation is increasingly green and our issuing clients and investors are increasingly interested in social impact. It also makes sense for us to be involved in developing this market due to our experience and capability, and not just in Australia.
One of the things I enjoy most about social impact as well as green markets is that the cross-discipline aspect brings people with different skills and backgrounds together across the bank. Whether it’s securitisation, bonds or loan syndication, you need a variety of skills to execute these deals.
CommBank is well positioned to innovate in this space due to the depth of our product expertise and the resources and capabilities across the bank including in customer advocacy, sustainability and community engagement. Another reason it’s part of our strategy and a priority is that working on these deals is inspiring. Our people put their hands up to work on a social-impact bond, for example, even if it’s on top of their day job or takes more effort, because they feel more connected to the bigger picture and can see directly how they’re giving something to society in a way that is relevant to their roles and skills.
When working on deals, our teams work together to think collectively about how green or social-impact investing aligns with the organisation’s overall vision, our corporate-responsibility strategy, and how it might provide us with a point of differentiation or commercial capability longer term.
The other part of this is how we measure and report on the work we’re doing through social-impact investing. Our annual corporate-responsibility report shows the work we are doing above and beyond the numbers, and institutional investors see nonfinancial metrics as an essential measure of the overall health of an organisation.
To show that it is really part of NAB’s values and direction, in September 2015 we announced a commitment to undertake lending and financing of at least A$18 billion to support the transition to a lower-carbon economy by September 2022. In two years we are very well on track with this target – which is a reflection of NAB’s commitment to this strategy.
Another example is gender equality. This is one of the social issues facing society, hence our leadership and creation of the social bond around gender equality – to show NAB supports this issue.
For us it’s about how we can develop products that deliver both a financial and a social return. The wealth of money that is seeking opportunities to deliver a positive social or environmental impact, as well as a financial return, is overwhelming and it’s continuing to grow.
Throughout the organisation at NAB we all understand we have a social purpose in the community and this aligns perfectly with the bank’s vision to become Australia’s most respected bank. Our purpose is to ‘back the bold’ to move Australia forward.
Deal highlights: Commonwealth Bank of Australia
For Commonwealth Bank of Australia, its role in developing the social-benefit bond (SBB) market is a highlight. The bank is also proud of being an arranger on the first green bond, globally, done by a university in the US private placement (USPP) market.
LING If I have to pick one, it would be the SBB we helped structure for The Benevolent Society of New South Wales. While the deal was relatively small financially at A$10 million (US$7.9 million), it is a unique product and the first in this particular suite – and I am most proud of the tangible and very real difference it has made.
As a banker, I’m not used to thinking about or dealing with foster care or at-risk children. It was extremely ‘real’ to sit at a table with police, the Department of Community Services and foster carers, to talk about a confronting issue and come up with a solution that has really made a difference. It has helped more than 400 families in just a few years.
If I could pick a second deal, it would have to be the Monash University USPP transaction as it was the first university globally to do a green USPP, and also highlights our international expertise.
MARKET DEVELOPMENT
Swiss What has been your bank’s role in developing the domestic capital market for green and other impact bonds?
So education is a big part of what we’re doing to develop the market. This includes education around the process of issuing these types of bonds, and dispelling myths about how hard it is. A lot of this comes down to connecting treasury teams with sustainability teams. Where we get the most traction and the most interest is where sustainability teams are core to strategy or very closely aligned to treasury teams.
There are different levels of knowledge and awareness of how the market works in the corporate world. I think there’s general acceptance that you get access to a broader range of investors with a green bond. But we are still dealing with concern around the lack of a pricing benefit, and there is scepticism about it being ‘just marketing’ or greenwashing.
We followed this deal with our euro climate bond earlier in 2017. It was an interesting transaction because we were marketing to European investors as opposed to domestic accounts. This involved a whole new dimension of scrutiny. The calls David Jenkins and I did with investors offshore were very, very rigorous. It was at that point that I felt great relief that the team had insisted on a framework that was robust, top of its game on a global-standard basis, compliant with the Climate Bond Standards and the Green Bond Principles, and we had addressed all the issues European investors wanted us to in the framework.
Although we had already done one climate bond, the rigour around building on the framework we had developed made the euro deal quite satisfying. Especially as we received a very positive reception from investors.
Taking these learnings on board, we then started working on the social-bond framework, which we built to the standard European investors were looking for. The gender-equality bond NAB issued this year was the first of its kind globally.
Since I started with the bank, in late 2010, I have been immersed in this sector. We began talking to investors as early as 2011 about how we saw the market developing and getting their thoughts on whether SRI, initially green bonds, made sense for them and their investor bases. You can see we had to commit resources to this sector way before any deals were issued in the domestic market. It’s only now we are seeing the recognition come through – for example, the CBI team has given NAB a green-bond pioneer award.
The World Bank deal we brought to market in April 2014 was about two years in the making. While the end result was a vanilla green bond that could be seen as an ordinary supranational, sovereign and agency (SSA) issue, we spent considerable time working with the issuer to ensure the investors that were offered the bonds were really taking environmental, social and governance (ESG) issues seriously. World Bank didn’t allow us to allocate to some investors because the issuer was clear from the outset that it wanted the inaugural trade in this market to reward investors with SRI-specific mandates and funds.
As the first benchmark deal, the transaction allowed discussions to take place for further issuance. So you could argue that this deal was the cornerstone for setting up all the transactions that followed.
As part of this process, we also spent a lot of time listening to investors. This allowed Westpac Banking Corporation, when structuring its own green bond, to ensure that it was perfectly formed to meet investor requirements.
Deal highlights: National Australia Bank
The National Australia Bank (NAB) duo choose their own bank’s climate bond – the first to be done by a bank in Australia – and award-winning gender-equality bond as deals worthy of particular mention.
JENKINS For me it was what we did first – finally getting NAB’s climate bond into the market. It took a long time – we started working on it in 2011 and it took until the end of 2014, working through a host of challenges both internally and externally.
This was a great collaborative effort. We drew on people from areas as diverse as social innovation, sustainability, governance and risk, the clean-energy and infrastructure team, operations, legal, and sales.
Then we also had to partner with investors to bring them along on the journey, as well as working with the Climate Bonds Initiative (CBI) team as they developed their original standards and used us as a pilot. We were the proof point in the sense of whether it could be done and how it would work from an issuer’s perspective.
After all this work, to see the market accept our framework and issuance was very pleasing. The other Australian banks have all followed our approach in the sense of getting their bonds certified by CBI. We have also been able to take the learnings and work with other clients to issue green bonds.
ZILELI I would have to say the deal I am most proud of is the social, gender-equality bond. For NAB, one of the major banks, to go out there and issue a bond that supports gender equality was a very bold statement to make.
The framework and the actual bond itself were both very innovative, but for me what made this bond special is the leadership NAB has taken on a social issue that resonates across the globe.
Swiss Having spoken to both issuers and investors in the domestic market, what is the potential for the SRI market to grow? Will it develop into a viable asset class in its own right, or are we more likely to see intermittent deals? What is driving it and why now?
I think the appetite of and pressure from investors is also a major factor. But it’s also about what makes economic sense. The technology to upgrade buildings or switch power sources to renewable energy is becoming a lot cheaper, which is contracting return periods. There are actually economic benefits to making these investments.
On top of this there’s a realisation that the world needs to transition to a low-carbon economy urgently. People are now taking a longer-term view around asset ownership and asset management.
I still think the market will grow but we will see less frequent deals than in offshore markets, due to the nature of the Australian domestic market.
On green bonds, offshore issuers will come to this market when the arbitrage works for them. This will always provide a strong base for the market.
I definitely think this market has the potential to grow. We are starting to see a groundswell of movement and support for investing in socially responsible assets. It started in the equity space and now it has shifted into the fixed-income space. We need to see more people demanding their funds be put into socially responsible assets in order for the market to grow.
These bonds are now part of the discussion we have with issuers. If the continuing inflow of dollars into the responsible-investment space continues, there’s no reason this market won’t continue to grow. The SDGs are helping with this – it’s becoming a default language in the bigger end of the investor universe globally. This may take time to filter down to Australia, but is growing based on our discussions across to the government sector. The banks are all embracing the SDGs, corporate Australia is too, and so are companies in New Zealand.
Deal highlights: ANZ
In choosing which deal it is most proud of bringing to market, the ANZ team says the transaction from Investa Office Fund was a significant milestone.
TAPLEY Our own transaction is worth mentioning. We are also very proud of bringing the first corporate, Investa Office Fund (IOF), to the green-bond market in Australia in 2017 – this was a significant milestone. The IOF deal was closely followed by its sister fund’s deal, and together they created a lot of momentum and a general realisation that the green-bond market is real and available to tap into when the timing is right.
Investa Property Group is one of the most highly rated property companies in Australia for sustainability. The company prides itself on its sustainability credentials and culture, as well as the very high-quality nature of the buildings in its overall portfolio.
It was also the first corporate in Australia to put in place science-based environmental sustainability targets, which it did at the beginning of this year.
Issuing a green bond was about aligning its funding needs with the strategy around sustainability. The green bond was a relatively straightforward and obvious thing for IOF to do due to the nature of its portfolio.
Swiss What about the potential of growth for the SBB market?
There were problems on both the supply and demand sides when we first started working on SBBs. Now the demand side of the equation is pretty good and the challenge is the supply side, as there is a lack of social projects you can scale and measure. There are a few organisations that can handle scalable projects so I think we can get there over time, though. However, relatively quickly to get to the hundreds of millions we would like to see, a social-housing bond-aggregation model would be a good step.
The holy grail for social-impact finance that we all seek is scale, and the key to scale is continued growth on the demand side. If we have a steady stream of investors knocking on our door asking us what’s coming next, it will really drive the market to think harder and more laterally to come up with transactions. It would also help if we could find a more standard way to structure and document social-impact bonds as they are still too complex to scale.
We were visited by an international guest who was involved in the first social-impact bond in the UK. He suggested that, even though the UK social-impact bond market was more advanced, it was still too early to tell where the market will lead. We hope to learn from the experiences across Australia to create more consistency in approach and structure of SBBs and therefore create efficiencies within the process.
We have completed two SBB transactions, with the NSW and Queensland governments, and we’re working with the Victorian government on a third. With this experience, we are finding ways to do them faster and smarter each time.
CORPORATE POTENTIAL
Swiss The most consistent Australian deal flow so far has come from the banks. SSAs and two semi-government issuers have also issued SRI bonds. There has been limited activity from the corporate sector. Do you think this is the issuance pattern we’re likely to see going forward, and do you anticipate more green-bond issuance from the corporate sector?
We have seen some corporate issuance and we expect to see more corporates looking at the market – among our customers, for example, a number of our clients are either investigating or preparing for green-bond issuance.
In terms of sectors, property is an obvious one to mention. Because there are National Australian Built Environment Rating System ratings for buildings, it’s easier for investors to get their heads around how green a bond that comes from this sector actually is. Also, the property space is the most well-supplied of all sectors in the Australian corporate bond market. So it’s natural to see green-bond issuance from this sector.
I wouldn’t limit growth to one sector, though. This market will develop across a range of sectors.
Green bonds are well understood in the corporate space – issuers can see that if they are investing in green infrastructure, renewable energy, and green buildings there is an easily understood impact measurement. In the short and medium term, these are the types of sectors where we will see growth.
Then you build on this to see which issuers are making a positive social impact – they can overlay green and social. If you apply this lens to the corporate sector there’s a much bigger universe. We think, going forward, there will be more corporates looking at sustainability – which aligns the green and social elements together.
Corporates are funding more for corporate-financing reasons, they’re less frequent borrowers in the capital markets. I believe we will see more and more corporate SRI issuance, though, to follow demand from investors and consumers. It’s great for the brand and you can actually get a pricing advantage and diversification from printing a green bond. So it makes sense for large corporates.
Measuring impact
It is all well and good to issue or invest in a green or social bond. But investors want to measure the impact of their investments and borrowers want to ensure they are reporting in a way that ties in with the developing trends in impact measurement.
JENKINS Impact is the first question we are asked – what impact reporting are you doing and how are you doing it. If you look at the green-bond market as the precursor to where we are now, it has taken a while for the market to land on a common metric.
It was led by the work the supranational, sovereign and agency issuers did a couple of years ago around developing a harmonised framework for impact reporting.
The Climate Bonds Initiative (CBI) has been very good at articulating these measures into benchmarks that allow them to give technical rigour around their standards. This gives us comfort because when we talk to investors we can say low-carbon transport in Sydney or Melbourne is aiding the journey to a two-degree climate-change world by 2050 and here’s the proof – it’s around reducing the emissions footprint over time via modal shift and transitioning to a lower carbon-generation mix.
BUY-SIDE OBSERVATIONS
Swiss What are the main developments on the buy side in Australia? Are more bespoke SRI funds being set up or is SRI being incorporated as part of the overall process?
At the next level there are high-net-worth individuals, and undoubtedly SRI is going to become a more mainstream product for these clients. Meanwhile, retail investors are potentially more difficult due to different rules relating to listing and related documentation.
This has a win-win property to it as social-impact investing is investing in something that is not correlated to the economy – and investors love uncorrelated risk.
A good example of this in our wealth arm, BT Financial Group. It has SRI-type funds, but in addition to this it actively considers ESG factors in its investment analysis and decision-making process.
Regarding whether there are specific funds being set up or fund managers using ESG as an overlay, it’s a mix. There are only around 20 dedicated green-bond funds globally – that’s less than US$2 billion, or less than a percentage point of the green-bond universe. So it’s tiny.
LOOKING TO THE FUTURE
Swiss What are the main challenges to SRI market development?
Pricing and cost are also challenges. Longer term there needs to be a price differential of some sort for this market to really develop. We are still in the very initial stages of this and there are times, particularly in the secondary market, that we see sustainable bonds trading better than vanilla bonds. Whether this can be translated into a benefit for new-issue pricing remains to be seen.
If we can get to a point where an issuer can achieve a more attractive cost of funds, albeit a small one, this will lead to more development of the sector. We are starting to see some of this in Europe, and in the domestic market Queensland Treasury Corporation’s green bond is trading through the issuer’s curve. So there are some signs but more will be positive for the market.
Generally, with more regulation and increased costs, banks have to remain focused on continuing to grow their overall businesses but also deliver these products – which don’t make any money. This is the balance we are looking to attain and maintain.
Swiss What kinds of things are at the top of your wish lists with regard to developments to take place to ensure we maintain and even increase momentum for investing with impact?
On the demand side, I would like to see more of the community demanding that their funds be put to work in a socially responsible way and addressing the transition to a low-carbon economy as well as other societal issues.
Harmonisation around how to judge a green or social bond is also important. Agreeing on a standardised approach would help the development of the market. Finally, I’d love to see the SDGs become part of everyone’s discussion when they talk about investments.
The same can be said for the potential of the SRI bond market. People need to be patient and to recognise that markets go through steps of building benchmarks to allow relativities to develop. This is what will make the market itself more sustainable going forward – rather than simply trying to rush out deals.