Roundtable: Going green with bonds

Australian issuers are at the front of the pack when it comes to green bonds. They are only just getting started.

Roundtable: Going green with bonds
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It was initially thought that issuing a green bond would offer borrowers a cost saving. Has this transpired?

Goddard: From a borrower’s perspective, the decision to issue a green bond versus another bond instrument is always a commercial decision based on which market offers them the best pricing at a particular time. The Westpac bond showed that a green bond and a vanilla bond can price flat to one another. When issuers were first looking at these instruments there was a perception that issuing a green bond would be cheaper but this hasn’t eventuated. Now the focus has shifted and issuers have become focused on establishing a curve and building a viable market. Over time there may be a saving that comes with issuing a green bond.

How long before such a decoupling occurs?

Goddard: The domestic market needs to develop considerably more depth and liquidity as a whole for this to happen.

The debate continues

What about the issue of secondary market liquidity which Pablo at Colonial First State raised earlier. How can this be improved?

Milis: We have found that where there is a seller there is always a bid, but there aren’t many sellers around. For as long as primary supply is less than demand, this dynamic will exist.

Hartnett: We hold about A$90 million in green bonds at present and we don’t classify them as any less liquid than our other bonds. We know that if we had to sell them quickly, we would be able to find a buyer.

Okay, looking ahead at the potential pipeline for green bonds in Australia, what type of assets are likely to be eligible for green bond classification?

Woods: Following on from the bank and semi-government deals, the next issuers are likely to be the utility companies and the commercial property developers. After that, the field of domestic corporate issuers quickly thins out. However, there is plenty of potential for offshore borrowers to sell Aussie-denominated bonds into the Australian market. There is growing awareness of the demand for green bonds from local institutional investors, especially the big superannuation funds.

Salmon: If we look at global precedents, particularly China, there is a possibility to structure deals around the transport sector such as rail infrastructure.

Lovell: We are excited about the potential in the renewable energy market. In Queensland alone the current total renewables capacity in the state is a fraction of the capacity required in the next 15 years if the government is to meet its renewable targets. This is a massive funding requirement and there is only so much that can be absorbed by the banks. We see significant potential in other asset classes related to energy efficiency as well.

Woods: I agree there is plenty of money needed to meet renewable energy targets in Australia and the equity market will be able to fund some of this. But there are many hurdles to be overcome before these targets can be turned into bankable assets, not least the issue of regulatory settings.

Hartnett: As a fund we don’t have any issue with technology risk and the cost competitiveness of new-build renewable energy versus new-build fossil-fuel energy. We are more concerned about how renewables can compete with existing fossil-fuel electricity providers when they have had all their upfront costs written off over 30 or 40 years, and are at a stage of benefiting from efficiencies. Renewable assets represent disruption technology and are therefore harder to value.

Further discussion

What about the commercial property sector as a source of deals?

Goddard: The commercial property sector already has its own framework of best practice benchmarks for sustainability such as the Green Star rating system which makes this an easy sector to measure and turn into a fixed-income product. Not only is there a solid pipeline of new stock being built in commercial centres around Australia, there is a large stock of existing buildings that are being refurbished that could be included.

Lovell: The standard of Australia’s existing commercial building stock is generally very poor. There is a great opportunity for building owners to use the green bond market to refurbish their buildings and turn them from a 2.5 star building to a 4.5 star building, for example.

What sort of innovations have we seen in more recent deals?

Lovell: The Flexigroup transaction was interesting. It had a A$50 million green bond tranche within a $260 million general fixed-income deal. The green tranche was identical in almost every respect to the equivalent non-green tranche and yet Flexigroup was able to use scarcity to drive price differentiation. We expect to see issuers try and be a bit smarter around some of the structuring techniques as time goes on.

Milis: By offering a green tranche within a standard bond issue – which is also what Westpac did – you are able to issue a larger amount of fixed bonds. These multi-tranche deals will become the norm.

I can see how issuers benefit from a level of kudos by bringing their first green bond to market, but what is likely to motivate them to come back again and again?

Pearson: I have asked this question myself and it is something investors are concerned about. I can see the advantages of doing an inaugural issue – it brings a certain public relations benefit. But does this benefit trail off in the third or fourth deal? Investors will be expecting ongoing verification and monitoring of the green assets and this adds to the cost of maintaining a green bond programme.

Goddard: Yes, however, once you have the structures in place and you have issued once, it is easier to reissue and to keep the monitoring process going. I think the corporate feel-good factor that comes with issuing a green bond has a certain amount of stickiness. And, of course, the other benefit is the ability to access a new pool of investors. This Australian pool might not be deep at the moment but the whole market is growing and as more green bond investors emerge it will be important for issuers to show they have a track record in the green space.

Hartnett: I would also argue that it isn’t prohibitively expensive to issue a green bond. It’s something like 0.1% of one basis point and corporates and governments should be prepared to wear this cost if they are serious about de-risking their assets.

Is there any equity upside for a corporate to issue a green bond? Do shareholders really care?

Goddard: I believe shareholders have an awareness of the issues around carbon footprints and sustainability, and public companies recognise this. It has become necessary for all companies these days to have some sort of policy statement about their approach to sustainability and how they plan to minimise their environmental footprint.

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