Taking the lead on sustainable finance evolution

Dozens of borrowers that might not have been able to identify or record data for specific assets suitable for use-of-proceeds (UOP) financing have been attracted to the SLL market by the prospect of aligning their corporate sustainability goals with funding. SLLs also offer pricing incentives to achieve those goals.

For BNP Paribas in Australia, the advent of sustainability-linked principles within financing documents broadened the array of clients with which the bank is having conversations about sustainable finance.

Mark Hutchinson, co-head of corporate clients group, Australia at BNP Paribas in Sydney, tells KangaNews Sustainable Finance: “In the early days, when all we could really talk about was green bonds or loans, companies would often suggest they were genuinely on a sustainability trajectory and were taking action – but this did not necessarily produce a UOP funding opportunity. Similarly, others were investing in their sustainability strategy but not at the scale that would warrant a green bond.”

The move to sustainability-linked instruments and the resulting opportunity to link a more sizeable proportion of a company’s capital structure to the sustainability journey, started to “ring bells”, Hutchinson adds. It created momentum that led to the origination of a raft of ground-breaking transactions in the loan space and, more recently, in sustainability-linked bond (SLB) format.

BNP Paribas was a sustainability coordinator on Australia’s first syndicated SLL, a A$1.4 billion (US$1 billion) facility for Sydney Airport that closed in May 2019. It was also a programme arranger and joint lead manager on the first SLB by an Australian issuer – Worley’s €500 million (US$553.1 million) deal – and a sustainability coordinator on the first Australian dollar SLB, a A$1 billion print by Wesfarmers. Both these SLBs came to market in June 2021.

The use of sustainable finance is set to soar to even greater heights as Australian companies confront the reality of energy transition. In May 2021, the International Energy Agency published Net Zero by 2050: a Roadmap for the Global Energy Sector, a report predicting annual global investment in renewable energy will have to reach US$4 trillion by 2030 if the world is to reach net zero by 2050. This represents a fourfold increase on current investment in less than a decade.

The reality of the scale of this task is starting to reach boardrooms. “There is a sense it has been somewhat theoretical until now, with action lagging. But companies are clearly starting to confront the energy transition challenge through electrification and investing in power storage,” reveals Chris Ruffa, Sydney-based head of capital markets at BNP Paribas.

This includes the deployment of interim targets to pace the low-carbon transition. Increasingly, Australian businesses are following the global lead by putting in place not just net zero by 2050 commitments but markers for 2030 and 2040. These are particularly useful for alignment with financing structures as corporate KPIs are increasingly aligned with the tenor of funding facilities coming to market today.

The bank’s role is to support corporate transition. Despite the growing urgency of the task, this includes companies that are in the early stages of their own journeys. BNP Paribas has a long and proud history in the resources sector, for instance, and is keenly aware of the challenges and opportunities it presents in the drive to a low-carbon economy (see box).

Much of the work takes place long before a corporate borrower is able to bring a sustainability-linked or UOP transaction to market. Ruffa explains: “The bank’s MO is to walk with our clients – particularly those clients that acknowledge the challenges they face. We are not going to be rushing to do labelled products with those in the earlier stages of transition. But if they are genuinely committed to addressing the challenge our role is to support and shape their response.”

Hutchinson adds: “We hope our conversations with clients are such that we would be able to draw them into a situation where, if necessary, their ambition gets greater. This is not to say, though, that we absolutely would not support a journey that starts from a place we believe could be stronger.”

Investment in energy transition could change the nature of borrowers’ engagement with sustainable finance, Ruffa argues – and potentially spur much greater uptake of UOP instruments.

UOP has found some useful applications in corporate Australia. A clutch of property-sector issuers have issued green bonds to finance low-emissions buildings, for instance. BNP Paribas was also a sustainability coordinator on a A$1.8 billion loan facility for Reliance Rail that closed in March this year, which was notable for its size, sector – public-private partnership – and for combining UOP and sustainability-linked features.

But the most common meeting point of corporate strategy and sustainable finance instruments so far has lent itself more to sustainability-linked debt. This is the growing awareness within finance and treasury teams of the importance and value of aligning their approach to financing with environmental, social and governance (ESG) objectives.

UOP has lagged, by contrast, because of the dearth of actionable eligible investment opportunities of scale. “It will be interesting to see how this evolves in future, though,” Ruffa says. “I do not expect any abatement of the alignment between corporate ESG targets and financing – this is going to be the new normal and it will be highly significant for capital markets. I also believe the realities of energy transition, and the type and size of investments companies need to make, will provide more momentum to the UOP market.”

Already, companies and developers in more sensitive sectors are trying to isolate areas where they can invest and make an impact. This might mean green or transition finance, but either way Ruffa believes it may lend itself to increased deployments of UOP structures.

“We have seen an explosion of sustainability-linked instruments in the last few years. But I believe both sustainability-linked and UOP will grow significantly over the coming years,” Ruffa concludes.

While the nature of corporate Australia’s financing needs may start to lend itself more to UOP instruments, the specific choice of funding instrument is secondary to the influence sustainable finance can bring to bear on corporate entities as a whole.

The ESG derivative is starting to emerge as a complementary product for corporate borrowers. The cross-currency swap is a consequential feature of offshore issuance for the overwhelming majority of Australian corporate borrowers that do this type of financing. Hutchinson argues the ability to add a sustainability-linked derivative to foreign-currency transactions certainly seems to make sense – though he also says discussions with borrowers on the topic are not yet typically at a mature stage.

“I can certainly foresee a world in which ESG derivatives are a natural accompaniment to deal announcements. I am not sure why issuers would not want to link derivatives to the same sustainability principles as their borrowing – and to disclose that they have done so,” Hutchinson comments.

The impact of ESG derivatives on corporate cost of funds is always likely to be marginal. The point is to maximise the impact of borrowers’ sustainability commitments by applying them to as many aspects of financing as possible.

“Each instrument has its role to play in amplification of our clients’ ESG agendas and each also brings a focus on different time horizons, depending on the underlying product tenor. At the same time, every aspect of sustainable finance does not have to have the same impact or be a massive difference maker on its own,” Ruffa explains.

He continues: “For instance, a sustainability-linked approach may be less transformational compared with a significant UOP transaction, but it still has a role to play in making sure KPIs are relevant to the business and pushing at the edges to try to make the strategy move faster.”

A related step forward in market evolution is the idea of bringing everything together in a single sustainable-finance framework within corporate treasury. This document can then be used as the basis for sustainability criteria in future debt facilities and other financial instruments such as ESG derivatives.

The SLLs BNP Paribas worked on as joint sustainability coordinator for Coles and Treasury Wine Estates demonstrate the value of this concept in practice. Each of these companies used its platform to migrate existing bilateral lending facilities to adopt SLL KPIs.

“What we were able to achieve was establishing a similar type of deed structure specifically for sustainability,” Hutchinson reveals. “All the company’s ambitions and KPIs for the ensuing period are embedded within these documents. As such, they do not pertain to a particular instrument but have the capacity to be linked to any financing agreement.”

It is similar for Reliance Rail. Its green SLL was a syndicated facility, but during development the borrower put a sustainability framework in place that it will be able to reference as the basis for ESG criteria should it wish to consider future labelled instruments. Utility borrowers, meanwhile, should be able to piggyback annual regulatory interest-rate resets off a similar framework and thus apply sustainability KPIs to existing debt.

“It will be increasingly commonplace to have a central document in place that lends itself to multiple products. This means sustainable finance will move beyond being specific, event-driven funding,” Ruffa says.

A glance back over just two or three years shows how quickly the sustainable finance market is evolving. Even within the SLL format, the ambition and precision of the most recent facilities transactions has superseded those completed in the early days of the product.

Borrowers want to know that what they bring to market will remain relevant for its lifespan and will not require a completely new work stream when refinancing looms. This has not always been easy to do, especially in the early days of new sustainability products.

Sydney Airport, for instance, chose to structure its SLL around an ESG rating covering indicators across seven material issues, the evaluation of which was based on a third-party assessment. Ruffa says this represented best practice at the time and emphasises that the issuer and coordinators remain very proud of the outcome, notwithstanding that market evolution means a rating-only SLL has now become a less common approach.

“The best way to future-proof transactions is to do as we did with Sydney Airport and apply as much rigour to the due diligence process as possible, in the sense of working out the levers the borrower has available and how impact will be assessed. We had very detailed discussion with the issuer about the impact of various actions it could take and with the agency about its rating impact,” Ruffa comments.

The good news for borrowers is that part of the evolution of the sustainable finance market has been the development of methods to account for the dynamic nature of transition and investor expectations. It has now become de rigeur, for instance, for corporates to set interim emissions targets for 2030 and 2040 on the path to net zero by 2050. These lend themselves to financing that will mature before the end point is reached.

Hutchinson adds: “Borrowers themselves want to set up financing facilities that align with their sustainability pathway. Increasingly, companies want to have conversations about the right composition of KPIs that makes sense for them and their own journey, and, in a sense, puts them in charge of their own destiny.”

A notable recent development in this context is the incorporation in sustainable finance facilities of reference to areas a borrower knows need to be a focus but where it is not yet able to establish a measurable KPI.

Hutchinson reveals that, in 2021, BNP Paribas helped originate an SLL for a client that had a specific sustainability theme the bank felt could not be avoided as part of any credible marketing of an SLL to a wider bank audience but where the client was not yet confident to put meaningful, quantitative objectives around that theme.

“We worked very hard with the client on the formulation of a KPI covering the reporting it would do – a commitment to doing a full investigation on that particular theme with a view to the creation of quantitative objectives at some stage down the track,” he reveals. “In a sense, the KPI is to set a KPI in future on an issue that is critical to the borrower’s sustainability journey.”

Ruffa adds: “In doing so, our clients are not signing up to vague future goals but a considered commitment to invest today in the resourcing required for the relevant data capture and process implementation. They are very conscious of the reputational risk they bear in not delivering a baseline for emerging KPIs.”

With its European parentage, BNP Paribas believes it is well placed to bring the cutting edge of global sustainable-finance developments to clients in Australia. In a recent example, the bank arranged a €1.5 billion SLB for French supermarket giant Carrefour in March this year with sustainability performance targets connected to reducing packaging and food waste.

Hutchinson points out this is the issuer’s first SLB that does not include specific reference to emissions – a development he says BNP Paribas was discussing with Australian clients the day after pricing. While Carrefour has a greenhouse-gas reduction target within its overall sustainability framework, on this occasion it pursued underlying bond issuance linked to other key ESG metrics.

Hutchinson adds: “We like to ensure our clients are kept abreast of developments, evolution and the observations we are making, especially from markets that are perhaps a little more developed than our own. We want to be the conduit between our clients and developments we believe will be happening here in three or six months’ time.”