Money talks, but price is not the driver
Sustainability-linked structures put an explicit price incentive in place for borrowers to meet environmental, social and governance (ESG) targets – a change from use-of-proceeds structures, where the ‘greenium’ tends to be implied. Issuers still say differential pricing is not the primary motivating factor.
CHEUNG It was a question we received from our board when formulating our ESG-debt framework and looking to issue a green bond. It has always been difficult to demonstrate or quantify greenium, but we pointed out there is increased diversification and demand.
There is also greater engagement from investors – and we have seen examples in the market where there has been greater investor stickiness, which also helps with secondary spreads.
All these factors in theory translate to better demand and should also mean better pricing. It is just not something we can pinpoint or quantify exactly. But we believe there can only be upside – and this is how we sold it to our board.
DOLTON We are often asked whether issuers do it for a pricing benefit. I do not think they are doing it solely for the pricing benefit, per se – though pricing can help offset the additional cost of implementing stretch targets. If we were doing it primarily for a pricing benefit, we would have considered putting the ESG tag on a much larger tranche.
PRABHU From some of the commentary I have heard during this discussion, in the short run the motivation to engage in sustainability frameworks is partly to do the right thing, partly reputational and partly having a social licence to operate – which comes with cost.
But issuers may get a funding-cost benefit in the long run. It may even be necessary to attract capital. Depending on the time horizon, the rationale will change.
We talk about a greenium, but two or three years ago a lot of green bonds were actually trading at wider credit spreads than vanilla bonds. At that time, as an investor, we saw a good opportunity to extract extra yield. This changed around 12 months ago, by which point most green-bond issuance was pricing no wider than flat to vanilla bonds.
More recently we have seen deals like Mercury New Zealand’s green bond, which priced in November, come at a premium to a vanilla bond. It priced inside Origin Energy and it performed a further 10 basis points in the secondary market over a day or two. Issuers are starting to see a net funding-cost benefit from labelled issuance. This shows the market has certainly changed and matured over the past couple of years.
From an investor’s point of view, though, we look at opportunities on a relative-value basis. We are looking at the risk-return dynamic, so each security has to stack up on its investment merits relative to other bonds notwithstanding its ESG credentials.
YUAN Other than issuers like banks that can do one tranche in vanilla format and another green, we will never know what the pricing benefit is. However, there has been a lot of demand for labelled bonds and an increased stickiness of holdings – by dedicated ESG funds and because labelled bonds are rare. This must translate to a tighter pricing environment.
I think this was an interesting point about the recent Mercury and GPT deals. When an issuer’s whole business is green, it can be rewarded more by the market when it issues debt compared with those issuers that are toward the lighter end of the green spectrum.
In the short run the motivation to engage in sustainability frameworks is partly to do the right thing, partly reputational and partly having a social licence to operate – which comes with cost. But issuers may get a funding-cost benefit in the long run. It may even be necessary to attract capital.
LOVELL We certainly let plenty of deals run their own course. A number of transactions have completed in the market recently where we have not invested because we have finite capital – and it is taxpayers’ money – so we have to be prudent. We have a lot of other opportunities that we are eager to finance.
This said, we typically try to operate where the investment supports a broader strategic rationale. This can mean helping bring issuers to market – because some value having us in transactions, for a range of reasons. It could also be a case where we believe our involvement is appropriate in order to support good governance and discipline in processes that will benefit the investor market as a whole going forward.
For example, there is a lot of debate about good governance structures with respect to step-up approaches. We have seen some deals we did not like, and we gave feedback.
We also like to bring new types of issuance to market and try to build efficiencies. In other words, there is still a pretty healthy role for us to play across the spectrum of sectors and issuer types. We are always keen to ensure deals clear while reducing our investment as much as we possibly can because, as I said, we have lots of opportunities to pursue.
