Australia’s first SLB goes to the heart of transition

Wesfarmers says its sustainability-linked bond – the first in the Australian dollar market – lays out ambitious targets and addresses the group’s hard-to-abate business unit. The transaction also demonstrates willingness on the part of Australian dollar investors to engage with bespoke KPIs on the basis of a one-way pricing penalty if the issuer fails to hit its targets.

Wesfarmers’ A$1 billion (US$750.6 million) deal – split A$650 million and A$350 million between seven- and 10-year tranches – priced on 16 June. ANZ, BNP Paribas and Westpac Institutional Bank were joint sustainability coordinators and lead managers alongside Commonwealth Bank of Australia and National Australia Bank.

Luigi Mottolini, Perth-based executive general manager, group finance at Wesfarmers, tells KangaNews reducing carbon emissions is a key strategic objective for Wesfarmers. “The focus of the group is to be sustainable in the long term, and that means we need to be not just financially sustainable but sustainable across a range of ESG [environmental, social and governance] issues.”

Wesfarmers’ sustainability-finance framework allows it to issue more conventional use-of-proceeds (UOP) bonds as well as the new sustainability-linked bond (SLB) structure.

Mottolini reveals that the issuer selected the SLB format over UOP to address the Wesfarmers’ group’s most material ESG concerns, because the instrument provides the ‘brown’ part of the business access to sustainable finance as it transitions to a net-zero emissions goal.

“While green-bond assets have to be designated and accepted as green they would not necessarily represent the diversity of our business,” Mottolini says. “We could theoretically have issued a green bond to finance a specific asset without reference to the sustainability issues in the rest of the group.”

The sustainability-linked loan (SLL) Wesfarmers entered into early last year created a further level of interest to pursue sustainability-linked finance, he adds.

Wesfarmers last issued Australian dollar bonds in 2015 and also has two euro-denominated bonds outstanding. While the euro market has seen growing momentum in SLB issuance over the past year, Mottolini says Wesfarmers has seen demand for the product developing in Australian dollars to the extent that issuing in the domestic market was the most appealing option.

“One of the priorities in our funding over the years is to make sure we have a diverse range of sources available. Issuing into the Australian market adds to this diversity,” he confirms.

“While green-bond assets have to be designated and accepted as green they would not necessarily represent the diversity of our business. We could theoretically have issued a green bond to finance a specific asset without reference to the sustainability issues in the rest of the group.”

Deal dynamics

The SLB structure is gaining traction in global markets but key aspects of the deal – most notably the pricing step-up based on whether Wesfarmers meets its sustainability KPIs – were new to the Australian market.

The KPI aspect of the deal is a pair of 12.5 basis point step-ups each based on a clear target for the issuer. This is in line with international precedents, says Kate Stewart, managing director, debt capital markets at BNP Paribas in Sydney.

“We looked at international markets, where SLB frameworks have become more standardised and successful transactions completed, to structure this deal so it could work in the euro and domestic markets. The transaction was marketed to investors globally so we went with what has been established as standard in the international market,” she says.

There has been significant interest in the prospects for an Australian dollar SLB market given the explosion in activity in SLL financing over recent months. The question was whether bond investors would be able and willing to replicate the process of developing issuer-specific KPIs that takes place between borrowers and lenders in the SLL market.

Bond investors have been thinking about what SLB structures might look like in the Australian dollar market. The Wesfarmers transaction appears to meet expectations.

Shan Kwee, Melbourne-based portfolio manager at Janus Henderson, says: “In addition to companies taking on the reputational risk of achieving contractual sustainability commitments, it is important that coupon structures provide a reasonable incentive to reach the objective. The Wesfarmers coupon step size of 25 basis points in aggregate has become somewhat of a market standard offshore – and it makes more sense the larger the deal size, as it is effectively a larger penalty.”

Kwee adds that Janus Henderson was pleased the structure of Australia’s first SLB was relatively straightforward, for instance its use of one-way step-up pricing – rather than a step-up and step-down – and single trigger points.

The market overall appears to have responded positively to the Wesfarmers deal. Its seven- and 10-year tranches were marketed at 90-95 and 110-115 basis points over swap before launching at 85-90 and 105-110 basis points over swap. Final pricing tightened further, to 77 and 98 basis points over swap.

Andrew Brown, director, sustainable finance at ANZ in Sydney, says the process of establishing price guidance for the deal was the same as for any other corporate transaction. Given the issuer’s large exposure to retail, domestic retail comps were the starting points.

“The unknown bit was what the structure was worth – but our view going into the transaction was to let the market decide. We did not point to SLBs in Europe or other markets, for instance, nor pricing differentials between ESG-themed and vanilla bonds,” Brown says.

Patrick Taylor, Brisbane-based senior credit analyst at QIC – which also invested in the deal – says pricing was fair relative to Wesfarmers’ consumer peers after taking into account rating differentials and differences in underlying business profiles.

Mottolini says deal tenor extends the issuer’s debt maturity profile. While there was strong demand for 10-year tranche, demand was skewed towards the seven-year point. This also had an impact on the SPT timeframe.

Total demand reached approximately A$2.7 billion in the final book update, with 59 per cent of interest in the seven-year tranche. Domestic asset managers comprised the majority of the book (see charts 1 and 2).

Source: BNP Paribas 17 June 2021

Source: BNP Paribas 17 June 2021

Gary Blix, head of corporate origination at Westpac in Sydney, says the level of domestic support was particularly noteworthy. “The interest in this transaction was more than we have seen in any other trade for a long time and demonstrates to us that there is a growing appetite for investors to see more of this product.”

“We wanted a target that will encourage the team to continue to experiment to find ways to take the last 15-16 per cent of emissions out of the business. The target represents a modest increase in decarbonisation but also provides latitude for the business to try new strategies and technologies.”

Transaction structure

Wesfarmers’ SLB is structured to adhere to the International Capital Market Association’s Sustainability-Linked Bond Principles (SLBPs) and is externally assured by EY. The proceeds will be applied to general corporate purposes, including the refinancing of upcoming bond maturities in October 2021 and August 2022. The deal has two SPTs (see table), which will be measured and reported annually until the relevant trigger dates.

Wesfarmers SLB metrics detail

 DetailCoupon step-up if SPT missed (bp)Measurement periodTrigger date

Wesfarmers’ retail business – Bunnings, Kmart Group and Officeworks – to source 100 per cent of electricity requirements from renewable sources. 

12.5 31 Dec 25 31 Dec 25

Wesfarmers chemical, energy and fertilisers (WesCEF) division’s nitric acid ammonium nitrate production facility to limit average emission intensity to 0.25 tonne CO2e per tonne of ammonium nitrate produced, or lower.

12.5 1 Jan 24 - 31 Dec 25 31 Dec 25

Source: Westpac Institutional Bank 17 June 2021

The SPTs focus on the material ESG risks for Wesfarmers as it sets out on its path toward net-zero emissions by 2050. Roughly 95 per cent of scope-one and-two emissions from Wesfarmers’ retail business derive from its electricity use. SPT 1 is key to achieving the 2030 net-zero emissions goal set for the retail business.

SPT 2 is perhaps even more noteworthy. Wesfarmers’ chemical, energy and fertilisers division produces more than 60 per cent of the group’s scope-one and scope-two emissions, with the ammonium nitrate business the largest single contributor.

The sector is considered to be hard to abate, in this case because existing decarbonisation technologies are higher cost than available higher-carbon alternatives in the production of ammonia.

Issuers from hard-to-abate sectors tend to come under the greatest scrutiny for potential greenwashing in their use of sustainable-finance products. But market participants involved in the Wesfarmers deal – including investors – insist it is not just rigorous but ambitious.

For SPT criteria to be considered ‘ambitious’ under the SLBPs they have to offer a material improvement in KPIs beyond a business-as-usual trajectory, be compared to a benchmark, be consistent with the issuer’s overall ESG strategy and be determined on a predefined timeline.

Naomi Flutter, Perth-based executive general manager, corporate affairs at Wesfarmers, argues: “Whether considered in a domestic or global context, our SPT 1 is ambitious in both its aspiration for moving to 100 per cent renewable power and the timeframe for delivery – of 4.5 years.”

This sentiment is echoed by Janus Henderson. “We thought going from a baseline of 10-20 per cent renewables currently to 100 per cent for the retail operations was ambitious in the context of all global retail businesses. The timeframe Wesfarmers committed to is also very ambitious,” Kwee tells KangaNews.

Wesfarmers is already quite close to meeting its SPT 2. Based on an average from financial years 2019 and 2020, emission intensity was at 0.255 tonne per CO2e per tonne of ammonium nitrate produced. While on the surface the SLB goal may thus not appear to be a stretch target, reducing emissions in the sector is a complicated task and requires substantial investment.

“We wanted a target that will encourage the team to continue to experiment to find ways to take the last 15-16 per cent of emissions out of the business. The target represents a modest increase in decarbonisation but also provides latitude for the business to try new strategies and technologies,” Flutter explains.

She also points out that Wesfarmers has managed substantially to decarbonise its ammonium nitrate business over the course of the last 10 years. In fact it is more than 80 per cent decarbonised relative to where it was in 2011.

Mottolini adds: “We are currently 20 per cent inside our regulatory cap. Rather than operating within this, though, we are publicly and contractually committing to this target.”

Wesfarmers does not believe any of its competitors have publicly committed to a similar target, while its research indicates that its own target represents a roughly 40 per cent step-up on the average of its competitors globally.

Being clear and transparent about the challenges in lowering emissions for the ammonium nitrate process was key to the SLB’s success, says Tessa Dann, director, sustainable finance at ANZ in Sydney. “There is not a huge amount of visibility around the emissions of ammonium nitrate production globally. It was important to Wesfarmers and the sustainability coordinators to make sure this business, and the emissions profile of that business, were addressed as part of this transaction,” she says.

Kwee adds: “Despite being a significantly smaller revenue percentage of the company, the ammonium nitrate business had to be addressed in the SLB because WesCEF makes up 60 per cent of the group’s scope 1 and 2 emissions. It would have made no sense to us otherwise.”

The SLBPs require the benchmarking of a target to assess ambition, which demonstrated Wesfarmers already held a best-in-global-class emissions intensity figure, explains Joyce Jiao, Melbourne-based associate director, sustainable finance at Westpac.

“The 0.25 target – from a two-year average starting point of 0.255 – reflects the fact that the best available technologies have already been applied to WesCEF’s operations. But the bond further ensures that the years to 2025 will incentivise Wesfarmers to experiment with new technologies to fully decarbonise the business and really get the 2050 net-zero emissions reduction trajectory snowballing,” she says.

Sustainability strategy

As ambitious as SPT 2 is to lower emissions in a hard-to-abate sector, ultimately the technology to get close to zero emissions does not yet exist. During the marketing process of the transaction, there was also contention that Wesfarmers was already operating near SPT 2.

But placing SPT 2 into the greater context of Wesfarmers’ strong credentials in this space is key to understanding the market acknowledging the issuer’s ambitions.

Even though the Australian dollar market has been talking about SLBs for a while, every transaction will be unique in a way that requires greater attention from investors than UOP issuance has before, Dann says.

“Investors need to gain a deep understanding not only of a company's sustainability position and its future plans, but also the targets within the SLB and the technical detail behind those targets.”

The world still demands the output of hard-to-abate industries, Kwee says, and investors need to incentivise investment in technology that may not currently exist but needs to exist to achieve a 2050 net-zero emissions objective.

Kwee adds that the availability of sustainability-linked issuance comes down to the sectors in which companies operate as well as the credibility of an individual company’s sustainability strategy. “SLB lenders want to incentivise issuer behaviour into the future. What we were really looking for was that Wesfarmers captured its largest firmwide contributors to scope-one and two emissions.”

Putting in place formalised and documented objectives as part of structures and covenants centres net-zero in the strategy of management, board and the executive, Kwee observes. “In our view, setting interim objectives on a shorter time frame really allows companies to dedicate focus and capital resources across their business units.”

The financial penalty for not meeting the targets is material for Wesfarmers, but Mottolini insists the reputational impact of not meeting those targets is just as, if not more, important.

Wesfarmers’ ability to successfully establish a sustainable-finance framework and market this transaction, meanwhile, stems from the company’s longstanding commitments to ESG issues.

“It is not possible to establish a market-leadership position, particularly in the industrials division, without significant investment in research and development initiatives. An ongoing investment will be required over the medium-to-longer term for Wesfarmers not only to meet its 2025 target but the net-zero objective,” Blix says.

Taylor says Wesfarmers’ strong ESG ethos was critical to the success of the deal. Noting the company’s 2050 net-zero emissions goal, he adds that “the targets it sets itself have to be ambitious as well as achievable - and I think it has struck the right balance”.