Tying it all together – goals and commitments for 2021 and beyond
The closing session at the KangaNews Sustainable Debt Summit 2020 brought together bankers who are leading market evolution in Australia and North America. The discussion covered the pace of change, targets for the future and hopes for measurable progress in sustainable finance.
Davison A big talking point at this event has been the Australian Sustainable Finance Initiative (ASFI)’s roadmap. How will its delivery affect Australia’s sustainable debt market?
JENKINS It will raise the level of awareness among issuers and investors and, more broadly, accelerate transition. Many of the building blocks are there but progress has been frustratingly slow.
We are seeing a lot of action by state governments but this is the first time a roadmap has been put together by a collaborative group. Until now, the focus has been on watching – I trust the roadmap will be the catalyst for quicker action.
TAPLEY I agree. What excites me most is this has become a platform for the financial-services community to come together with other essential parts of the sustainability community, like academia and regulators, in a way we have not before.
Banks are really good at talking to other banks, superannuation funds are really good at talking to other superannuation funds and so on. But the ASFI roadmap process has given us a platform to look at the issue collectively. What will likely change is the power of the collective influence of the financial-services industry as we look to implement and execute the roadmap.
CHEN We will hear a lot more about ASFI in the coming years. We have seen reporting on it already, particularly on the recommendations for TCFD [Task Force on Climate-related Financial Disclosures] reporting by 2023 and the use of science-based targets.
The point here is that it is not just a glossy report with some nice recommendations: it is a roadmap that will be implemented over the next decade. I am really bullish on what ASFI will achieve. We have heard a lot about the New Zealand process and the EU taxonomy, and this is the Australian version.
Many people are looking for a silver bullet, for one recommendation that will change everything. Some also find ASFI difficult to grasp, saying it is too ‘woolly’ – covering broad areas such as strategy, disclosure and taxonomy. My reflection on this is that if it were easy the whole issue would be fixed already.
The goal of the roadmap is a system-level change. This is why there are 37 recommendations and, in fact, it started out at more than 100 recommendations. The task at hand is big but we will have to chip away at these recommendations with everyone coming together.
Davison What is the perception of what Australia is doing internationally? We like to think our market is leading where our government is lagging – but has this message spread globally?
WEST I think the private sector, in Australia and the rest of the world, has led on sustainable finance. We have seen the EU come up with a taxonomy and a green-bond standard, but this is something the market had already established.
I am actually a little worried that legislation could thwart market growth. I am a big believer in free markets and the private sector leading. From my perspective, this is how it has gone in Australia and I hope it continues – despite the regulatory push.
Davison There is much excitement about the US coming to the party on climate-change adaptation and mitigation. How hopeful should we be about the US?
WEST It is an exciting time in the US. The election on 3 November was followed the next day, before the results had been certified, by the Fed [US Federal Reserve] applying to join the NGFS [Network for Greening the Financial System]. This is the central bank focusing on the development of climate-change response in sustainable markets.
To see the Fed formally applying to join the NGFS the day after the election made me chuckle because a country has to be a Paris Agreement signatory to join. It shows the path down which the US is heading, which is one the individual states have taken for some time.
Do I expect net-zero emissions by 2050 to be legislated, as we have seen in other countries? No. But the fact that there will be more implementation around alignment with the Paris Agreement and that NDCs [nationally determined contributions] will come back means capital will increasingly flow in a sustainable direction. Most of the large asset managers based in the US are already following best practice.
PATRICK I agree wholeheartedly. Asset managers around the world are aligned but I am not sure issuers are. American corporates have not accessed the sustainable-finance markets in the same way Europeans have, partly because there has been no national climate agenda in the US.
All companies are going to need a strategy with a 2050 net-zero emissions goal if they operate in the G7 and beyond. I think we will see many issuers change their capex plans and strategies to align with this longer-term future – and to back this up with what it means for 2030 and 2035.
While we might not see a big response to the change of US administration from the investor community, I think we will see a change from the issuer community globally.
Davison Capital has been readily available globally for the past decade and there is no sign of this status quo ending. What will compel more issuers to engage with sustainable finance if they do not have any problems accessing capital otherwise?
CHEN You are right – markets are very liquid and there is a lot of capital at the moment. But I do not share the same concern. I can think of a number of deals in 2020 and 2019 where the ESG [environmental, social and governance] piece was tricky, even in unlabelled debt issuance.
The issuers were in coal-related sectors and, in the transactions I am thinking of, they had to consider alternative markets to generate the most efficient pricing. When it comes to roadshows and other discussions with investors, the ESG piece was front and centre and the scrutiny of ESG continues to heighten even around unlabelled issuance.
Questionable transactions will be called out in the market – as we have seen. I believe there are enough checks and balances in the market to ensure there is sufficient scrutiny of ESG performance. In short, despite markets being liquid at the moment, I think the attention to ESG matters for investors and continues to heighten.
JENKINS I agree that we have seen ESG translate into a real premium on a number of recent unlabelled transactions in Australia. They could have been done here but at a price well beyond what can be achieved offshore. This is a real case of an ESG risk premium as opposed to a ‘greenium’ or a saving from being able to price inside a vanilla bond curve.
The pool of willing and liquid investors for poor ESG performers will diminish over time. It is already happening in our market and perhaps with some of the US- and Asian-based accounts too. The wave of implementing ESG screening, on top of regulatory constraints, will really diminish active investors in this space over the longer term. This is no surprise.
We are already seeing research from rating agencies that factors in ESG risk. Some issuers will respond and some will not, and this will lead to a bifurcation of pricing for similar credits. Expect to see more of the same, I would say.
PATRICK It speaks to the fact that there is a strategic rationale beyond a pricing advantage for accessing the labelled or sustainability debt market across industry sectors. Issuers continue to receive a pricing advantage even in this low-rate, highly liquid market.
But they are also benefiting from other perspectives. A labelled bond market really is the proof of the pudding in how issuers are linking their ESG performance and ambitions back to corporate strategy. The benefit goes beyond the basis points of a specific deal: it is communicating a narrative to the market. From the equity side, our analysis suggests there is a valuation premium in the market from being viewed as an ESG darling. The correlation between equity and debt markets is strong for ESG leaders.
Davison The need to label debt is perhaps not the same if the market is factoring in ESG to overall credit risk. In the long term, will we continue to see green, social and sustainability (GSS) bonds?
TAPLEY There will be an evolution in the long term but we are quite far away from it. Picking up on the previous point, you are right – there is plenty of capital. But I think it is becoming more discerning.
For discerning capital to invest it needs to know what it is investing in, and this is the advantage of the labelled transactions on the investor side. On the issuer side, it is all about connecting funding to sustainability strategy and keeping access to pools of liquidity.
We will continue to see labelled issuance for some time yet. I do not think we have evolved far enough for ESG to be ‘just a thing that everyone does’ on the buy or sell side, or that it has been factored in enough for market participants to make a discerning decision on where they allocate capital.
We are all in jobs for the time being, in other words! Maybe the next generation of sustainable finance will be more embedded into the various parts of business units.
The social dimension
The sustainable-finance market is primarily still a green-finance market – focused mainly on environmental projects and outcomes. Social finance is a relatively small segment but many market participants have hopes for growth.
PATRICK I disagree that social does not have the same economic rationale as green does. There are many instances where the economic rationale is just as prevalent, if not more so, in the social space, and certainly it can be easier to measure the impact created. For those investors seeking to align their portfolios with a positive-impact world, there is a compelling rationale for social issuance.
JENKINS We already see it in the sustainability-linked-loan space, where there is clear opportunity, alongside environmental KPIs, to focus on social metrics – indigenous employment, health and safety, improving the diversity of workplaces, education levels, and so on.
Davison If world economies all, or for the most part, end up on a regulatory and legislative path to net-zero emissions by 2050 and perhaps 2040, do we need to score transition within this framework? In other words, should the market expect issuers to meet what their policymakers and regulators are demanding as part of the bigger picture?
WEST Even before we went down this path of legislating net-zero emissions, the requirement for companies’ sustainability strategies to be aligned with market expectations was already in place.
A company with no strategy, targets or KPIs coming to market with a transaction is a surprise nowadays. I do not know how well that would go in today’s world. A huge portion of external reviews talk about the company at large. I agree that, in an optimal world, labelled issuance would fall by the wayside. But, as Katharine Tapley says, I do not think this will happen any time soon.
I also think we need to own what net-zero emissions means. It does not mean that every single facet of the economy is delivering net-zero emissions. Canada and Australia are both heavily resource-dependent economies.
On the other hand, environmental transition affects every sector of the economy and we cannot just pick on our carbon-intensive industries and tell them they have to figure it out. Every sector of the economy must do better.
Microsoft is removing historic carbon – this is phenomenal. It has laid down the gauntlet for technology companies. Maybe every sector cannot get to net-zero emissions by 2050, but perhaps some sectors improve dramatically and others do even better. I think there will be across-the-board improvement but there will still be room for sustainable debt.
Everyone is talking about sustainability-linked debt. This is somewhat ironic given there have probably been fewer than a dozen transactions at this point, but it is clear there will be a role for it to play. The focus will be on how to do it credibly in any market for any issuer.
Davison Do panellists believe sustainability-linked products will develop in this space before longer-term evolution to full sustainability integration?
JENKINS Sustainability-linked opportunities, especially in the climate-transition space, is an obvious evolution. In the near term, issuers will struggle to bring credible, labelled green instruments that are clearly backing net-zero emissions projects, or close to it, in all cases.
Hard-to-abate sectors will still have a need for sustainability funding and I think sustainability-linked products make perfect sense here, especially if issuers have a clear and considered strategy that is Paris-aligned.
It should be a perfect opportunity to match strategy and funding. Alignment of treasury teams and the offices of the CFO, CEO and chief sustainability officer is becoming increasingly common. As this continues to happen at pace, expect to see more products in this field.
TAPLEY We want as many players in this market as possible. It is a big task to get to net-zero emissions and it is a big task to fulfil the UN Sustainable Development Goals.
The more instruments we have, the more opportunity there is for different sectors of the market to play into discerning capital. This is what transition and sustainability-linked instruments do. It is really important that we promote breadth of instruments, on both the buy and sell sides.
Davison Does this play to the demand piece as much as to the supply side? A comment at another event we ran suggested that labelled use-of-proceeds bonds might be suitable for, for example, retail investors who just want green assets, whereas transition finance and sustainability-linked products are perhaps a place for the more sophisticated institutional investors.
TAPLEY Possibly. I do not necessarily agree that retail investors cannot understand a sustainability-linked structure – it is pretty straightforward. In fact, it is probably easier to understand than worrying about whether proceeds are going exactly to the specified green assets. But yes, investor demand from retail right through to institutional is a big factor.
CHEN On the flip side, I think institutional investors still have great interest in labelled GSS bonds. Day by day, we are seeing more asset owners come out with net-zero emissions pledges. Translating this through the system, asset managers will have more mandates to invest in green and dark green – and this cuts across all investor types.
WEST An interesting debate is less about the end investor and more about whether we think sustainability-linked bonds will kill transition finance because it is so hard to define. In a lot of instances, our clients in hard-to-abate sectors are saying they will go down the sustainability-linked route.
JENKINS There will always be a subset of the investor universe that wants reporting on specific impacts, and needs to be able to point to projects and quantify things in easily understood terms for their end investors.
If we consider a transition bond to be a use-of-proceeds instrument, this is much easier to articulate than a corporate-wide instrument where the company is tracking toward a couple of broad metrics, particularly if those metrics do not align with mandate requirements.
PATRICK I agree – there is room for both. Investors, whether they are retail or institutional, want to measure impact. This is much easier to do with a use-of-proceeds bond.
Equally, transition pathways vary for economies around the world. Countries are at different paces with various technologies and different investments. If countries are keen to accelerate diverse capabilities, transition-labelled issuance is a great way to do this.
A WIDER MARKET
Davison There seems to be consensus that having all the product options available so the buy and sell sides can choose what is right for them is the way to go. But there is also a minority view that having a myriad of standards and trying to run all of these products simultaneously may end up confusing the market or result in greenwashing in a way that would not occur if we kept things simple. How do we deal with this view?
TAPLEY This is a risk, but it is incumbent upon arrangers like us to ensure that we are using, at a base-level, ICMA [International Capital Market Association] principles where we can and encouraging the market to develop from these to bring robust structures to market.
It is incumbent on us to push our borrowers toward the most robust structure they can put in the marketplace and not to be afraid to challenge borrowers during the process of structuring.
It becomes tricky, as I have observed in this market, when we may be working with a European or Asian arranger and we all have slightly different approaches. But I think this is a manageable risk.
JENKINS The ‘ticket to play’ is getting higher every time. Market participants expect more, not less. The days of issuing a green bond because there is a funding saving to be had but never returning to the GSS [green, social and sustainability] bond market – a hit-and-run mission – are long gone. Investors expect more. They expect issuers to be committed. There is a clear focus on the ESG strategy of the issuer – it is not purely on the use of proceeds, irrespective of the nature of the business.
PATRICK Investors are doing their own due diligence even for straightforward green-labelled issuance. I agree that it is incumbent upon us as underwriters and arrangers to hold our clients to the highest possible standard so institutional investors can do their due diligence.
But there is no sign that the innovations in the market now, and those to come, will lead to further concerns. The investors we speak with want to continue to see more innovation, more participants, more sectors and more geographies access this market.
TAPLEY As well as pushing the borrower community, we also need to push the investor community really to express and be clear, particularly when it comes to disclosure around impact reporting, what is it that they really want measured, what is realistic to be provided and whether they are actually going to use it. For instance, are investors going to ask for reporting if they realise they have not got it on an anniversary date?
We are working in an environment where there are no hard consequences for default. We are starting to see review events and information undertakings in the loan market. ANZ is pushing down this line, because we need to have some standards and consequences around this. But it is also incumbent on the buy side actively to participate once the deals are done, to help the market improve.
WEST This is such an important point and one that we need to be talking about more and more. The idea of it being a collaborative effort is something we should be talking about more openly as a global sustainable-finance community.
Because we do not have an agreed upon standard methodology – although it is clear we are seeing green shoots emerging in this area – what we expect to see is consistency and transparency.
Sometimes companies go a year without releasing an ESG report. This would never happen with an annual report or financial analysis. Investors and asset owners are the only ones who can drive this change.
We are only looking for three audited and published major reports each year from a company – an annual report, ESG report and maybe TCFD at some point. This is not too high a bar to meet nor too burdensome to encompass. I think this is absolutely something investors should be asking for.
Audience question We often hear about the massive funding need for sustainable assets around the world. Could the development of these assets be driven by banks offering preferable terms for the finance they provide? Also, do panellists actively talk with their clients about the risks of inaction?
CHEN The two questions touch on the same point, which is the overall risk profile of the underlying borrower. Various jurisdictions are talking about changing capital weightings and the like.
Even if we are not there yet, it is something we are looking at internally because if we have KPIs set on material ESG issues it follows that, as David Jenkins mentioned earlier, it improves the credit profile of the borrower.
One could argue lower risk means preferential rates and pricing, and this touches on the flip side. We talk to our customers on the risks of inaction. I mentioned earlier an example of the pricing of bond and loan transactions where the customers are emissions-intensive, and what this would mean for bank as well as investor appetite.
Audience question How important is additionality to investors, given most companies are already making ESG commitments and changes?
WEST Additionality is a reasonable question – it is something we need to focus on. But more and more I personally feel, based on what I hear from clients, that we want to be focusing on the acceleration of capital to the right projects. I appreciate the fact that it is frustrating to think, ‘would that project not have been done anyway?’
But the truth is, if we can incentivise the right types of decision-making from the corporate C-suite and strategy, and by doing so accelerate or get more capital to fund projects, this is a win. This is what sustainable finance is all about. How do we actually move the needle? We do so by financing sustainability issues.
CHEN I agree. Additionality is the entire point of sustainable finance. With sustainability-linked structures, we are achieving additionality in so far as the targets are ambitious.
It is an old debate on use-of-proceeds bonds. Investors increasingly expect impact reporting on how those activities deliver additionality. And, of course, it is not just about the projects and activities. It is also about the issuers, and how they are addressing the issues of climate change and ESG beyond the assets being financed.
Davison This conference is taking place at the end of an unprecedented year. What are today’s panellists most excited about in the sustainable-finance market moving into 2021?
TAPLEY I am really excited about the emergence of more instruments in the marketplace and the engagement from the buy side around transition and sustainability-linked products. This is really helping to broaden the use of discerning capital in the marketplace.
PATRICK I am excited about more and more issuers coming to market for the first time, across different sectors and geographies.
JENKINS I am excited about the mainstreaming effect of sustainable finance across large organisations, like banks, to investors and issuers and global capital flows. It is no longer pockets of capital that is doing it, it is a groundswell. We are heading in the right direction, but we can always be much quicker.
WEST The evolving role of corporations, and what is expected by society, is the most exciting thing for me. We have seen a lot of this play out during COVID-19 – holding companies to account for their role in society.
CHEN I would add definitions and taxonomies. I am really excited about tightening definitions around green and social. This will really help with some of the mainstreaming we are talking about.
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