ANZ and FinanceAsia present a roundtable discussion on Australia's green bond market.
The participants: Blathnaid Byrne, Group Treasurer, AGL; Tessa Dann, Associate Funding and Liquidity, Queensland Treasury Corporation; Harald Eikeland, Director of Syndicate, ANZ; Adam Gaydon, Director of Syndicate, ANZ; Gavin Goodhand, Senior Portfolio Manager, Altius Asset Management; Ivan Gorridge, Chief Financial Officer, Investa; Jeff Grow, Senior Portfolio Manager, UBS Asset Management; Rosie Johnson, Senior associate, Brookfield Asset Management; Sean Kidney, Chief Executive Officer, Climate Bonds Initiative; Matthew Moore, Head of Ethical Investments, Uniting Financial Services; Michael Momdjian, Treasurer, Sydney Airport; Katherine Palmer, Senior Manager Funding and Balance Sheet, T Corp; Graham Sinden, Director Climate Change and Sustainability Services, Ernst & Young; Katharine Tapley, Head of Sustainable Finance Solutions, ANZ; Christina Tonkin, Head of Loans and Specialised Finance, ANZ; Laurence Zanella, Treasurer, The University of Sydney; Moderator; Cherie Marriott, Australia Correspondent, FinanceAsia
Christina Tonkin: By way of introduction, I would like to welcome you all to this roundtable. ANZ has been an active player in the development of Australia’s green bond market as an issuer itself and an arranger of deals for other borrowers. Already this year we have worked on the largest ever Australian green bond for Queensland Treasury Corporation worth A$750 million, and deals for Investa Office Fund and Investa Commercial Property Fund which together raised A$250 million. The potential for this market is enormous and we hope that today’s discussion will highlight some of the opportunities.
FinanceAsia: Sean, as CEO of the Climate Bond Initiative, can you provide a global view of market trends for our participants.
Sean Kidney: Pension funds around the world have changed their appetite over the past 10 years and have become interested in doing good as well as doing well. A lot of large funds have a deep concern about the long-term impacts of climate change and the volatility it will bring to markets and their investment portfolios. As a product, green bonds allow them to play an active role in the shift to a low carbon economy. There is also growing interest in social and sustainability bonds. The preference is for labelled thematic bonds which are marketed as green and underpinned by solid rules, transparency and annual reporting. This gives investors a way to tell a coherent story to clients.
FA: How large is the current market for green bonds?
Kidney: Last year green bond issuance doubled to about $93 billion including bonds from China. In the first half of 2017 the market has grown by 50% helped by a French sovereign issue in January worth €7 billion deal. We know of 15 other sovereign jurisdictions now working on green bond transactions. Of course green bonds still only make up less than 1% of all bond issuance globally, so we are starting from a low base. Developments that are likely to lead to a deepening of the market include the creation of an endorsed taxonomy of certifiable assets in Europe, which will eventually be synchronised with the Chinese government’s taxonomy. The focus is on harmonising activities around the world.
FA: Are issuance levels high enough to have a material impact on climate change?
Kidney: No, we need issuance of at least $1 trillion a year to be adequately financing the transition to a low carbon economy. If we double the size of the market this year, then we should be close to $1 trillion by 2020. Growing a large liquid bond market offers the chance for companies with a refinancing opportunity but also the ability to finance new projects.
FA: What innovative deals have come to market in recent months?
Kidney: The big change in the past year has been an increase in dialogue at government level. Governments now see green bonds as a way of financing infrastructure, railways, water and waste treatment, and green buildings. We have also welcomed new corporate issuers such as Mexico City Airport which raised $2 billion last year for its sustainable building, water projects and light rail connections. This shows that organisations which may have been excluded on ESG grounds can issue successfully as long as clear guidelines are in place.
FA: Does the Australian market mirror global activities?
Adam Gaydon: The Australian market has developed to a point where we now have a variety of issuers in the green bond market – from semi-government and SSA issuers to domestic banks and corporates. When looking back over recent transactions what stands out is the quality of the order books. On all deals run by ANZ we have attracted real money investors who have bought between 75% and 90% of the bonds. This is a much higher proportion of real money investors than you see in traditional bonds. The buyers are not just large domestic fund managers but there is solid demand from smaller fund managers with ethical investment mandates such as those representing religious entities and local councils.
FA: What is driving interest from investors in this product?
Gavin Goodhand: Interest is partly being driven by the arrival of younger investors on the scene. Gen Y and Millennial investors have a strong interest in the environment and sustainability. They are putting pressure on their superannuation funds to offer ESG options and it is these reverse enquiries from grass roots investors that is driving demand.
Jeff Grow: At UBS, interest in green bonds has been initiated by institutional clients with a long-term focus such as life insurers and pension funds. Now there is a grass roots movement coming from industry and super funds, and every RFP we receive has questions about ESG and sustainable investing. This means asset consultants are looking for products and partners, and institutional clients are writing ESG requirements into mandates. It is an evolutionary change.
Blathnaid Byrne: From an issuer’s perspective we are pleased when we hear investors aren’t just following pure “dark green” strategies but are also keen to engage with issuers who might be considered “light green” – those that are transitioning to lower carbon profiles.
Grow: We don’t hold to the concept of dark green and light green assets. To us, dark green suggests an exclusionary stance whereas we have a broader inclusionary focus and will look at issuers who are on a path to reducing emissions. If an issuer has made an authentic commitment to following a lower carbon path, we want to be part of their future.
Matthew Moore: As a church organisation there are certain sectors we will exclude for ethical reasons, but our mandate is broadly inclusive. Our stakeholders recognise there are risks of having a zero-carbon threshold. It is more important for us as an investor to keep a seat at the table and be actively encouraging our companies to transition towards low-carbon activities. We are also driven by the long-term performance data. Investing in green isn’t about sacrificing returns – low carbon portfolios can perform consistently and in-line with other portfolios.
FA: How important is certification when it comes to analysing a green bond?
Moore: Certification is very important because we want transparency. We need to know what the proceeds are being used for and to have reports that we can share with our stakeholders. We also want to monitor the assets over time to ensure they are staying within climate principles. Certification will increase in importance if the regulatory environment changes and mitigating climate-related risks become written into statutory or fiduciary duties of care.
Katharine Tapley: And to add to that, what we see as an arranger is that investors want some form of independent verification of the bond structure – certainly certification is one way of achieving that, but it can also take the form of assurance or a third-party opinion, or a combination of these.
FA: For the issuers at the table, what has motivated you to add green bonds to your funding mix?
Ivan Gorridge: In 2016, in direct response to the Paris Agreement, Investa set an aspirational target of net zero emissions by 2040. A critical element to achieving this target is access to funding. We issued our first 7-year green bond through Investa Office Fund in March and followed this two weeks later with a 10-year bond for Investa Commercial Property Fund. The process of certification took a bit of work but it wasn’t onerous and was well worth it. In marketing the bonds we were able to access a new and diversified pool of debt investors, and it opened doors on the equity side too, giving us broader access to more capital avenues. For these reasons we believe issuing sustainable securities drives returns for our business.
FA: So issuing a green bond can offer investor diversification, but what about pricing? Is there a pricing benefit to issuing a green bond?
Gaydon: Issuers often ask us this. In our experience, green bonds tend to price flat to the issuer’s outstanding secondary curve – that is, at the same spread as traditional bonds. However, we have seen green bonds outperform in the secondary markets due to lower supply.
Tessa Dann: The pricing outcome of a green bond issue was definitely at the forefront of our minds. Our conclusion after an extensive domestic roadshow was that investors were broadly comfortable with the green bonds pricing in line with our benchmark bond curve. While the issue did not provide a pricing benefit and there are some minimal additional costs associated with issuing green bonds the outcome from a whole of state and investor diversification perspective was a positive one.
Tapley: Were there unforeseen benefits of issuing a green bond?
Dann: The deal was incredibly well received by the market. We increased our investor diversity and attracted new investors who would likely not buy our traditional bonds. Green bonds are now a key part of our funding program and we hope to issue at least once a year. Over time we would like to be able to use green bonds to fund new projects, particularly now that QTC Green Bonds have been incorporated into Queensland’s Climate Adaptation Strategy. Issuing a green bond has also opened dialogue with our clients around their projects and the transition to a low carbon economy.
FA: Were there also questions from investors about some of Queensland’s activities – such as coal mining – that aren’t aligned with low emissions?
Dann: Yes the conversations we had with investors were certainly candid and we respected their honesty. We were able to express that issuing green bonds is about supporting the transition to a low carbon future and I believe investors are comfortable with this.
FA: How flexible are the climate bond standards in terms of adding new assets to pool that would qualify with a green label?
Kidney: Essentially assets and projects must be commensurate with the aim of reaching targets in the Paris Climate Change Agreement. Many assets or activities don’t comply. For example, if an airline makes small reductions in emissions from its transport fleets this wouldn’t comply, but if it implements leapfrog changes in fuel usage in planes this would comply. Shifting to biomass avgas offers a 60% reduction in emissions. In each sector it can take some investigation into the assets to figure out how they tie into the Paris Agreement. For energy companies the best route at the moment is to issue a “use of proceeds” bond where the proceeds go towards building renewable facilities.
Goodhand: As an investor it can be difficult to stay on top of which assets qualify as green and which don’t. We would be concerned if we bought a bond one day that included some gas assets and then found in three years’ time that gas was excluded.
Kidney: We understand these concerns but we also argue that the science criteria needs to be dynamic. There needs to be some scope for transitionary investments – those that aren’t zero net carbon but are a substantial improvement on old practices. Biomass avgas is one such investment. It still emits carbon but 60% less carbon than traditional avgas. In the long-term, however, we need to make a switch to different kinds of energy sources. By 2040 we expect that electric aviation will be price viable, and at that time we might phase out bio-avgas as an inclusion.
FA: For those companies at the table that haven’t issued a green bond, would you consider doing so?
Laurence Zanella: Sydney University has issued two vanilla bonds in the Australian market in the past three years and if I think about the assets that the money was put towards – such as state-of-the-art research and development facilities – we probably could have issued green bonds. The reason we didn’t consider it at the time was a matter of price and the initial cost of setting up a green bond programme. For future bond issues we will definitely consider green bonds given the positive press it would provide for the university.
Rosie Johnson: Brookfield in Australia has been formulating plans to issue a green bond. I believe our first green bond in Australia is likely to include assets from our property portfolios. Most of our buildings meet green certification standards in energy and water usage so it makes sense for us to look at financing options which reflect our commitment to sustainable building development.
Katherine Palmer: TCorp’s net funding programme for the past two years has been minimal due to the impact of long-term asset leasing to the private sector. But we have been talking to our investors about their changing appetite for sustainable capital instruments and the conversations have been positive. I note that Moody’s and Standard & Poor’s have both set out frameworks for green bonds and I am wondering how investors view these initiatives. Are you likely to place any weight on Moody’s and S&P’s assessments?
Goodhand: We do the bulk of our analysis internally, so sustainability ratings from third parties only have limited value.
Moore: We also have an in-house ethical/ESG rating process, using an external consultant rating scale to assist in the process, but I see the involvement of the ratings agencies as another step in the evolution of the market. There are some investors who place a lot of importance on what the agencies say.
Graham Sinden: Is there anything the providers of assurance on green bonds, like Ernst & Young, can be doing to make it easier for funds to make investment decisions?
Goodhand: When assessing any bond the credit itself must meet a list of financial criteria and if all boxes are ticked, then we will preference a green bond over a traditional bond. In this case, the verification process is important because we know the issuer has gone through the steps and we have a transparent view of proceeds all the way through. As an end investor it is hard to do all of this verification work in-house.
FA: Is there a place in the Australian market for sub-investment grade issuers? Or what about issuing green bonds in other currencies?
Goodhand: We don’t buy sub-investment grade credits. We buy as low as BBB, which is in line with the Australian bond market in general. 95% of issuance in Australia is investment grade.
Kidney: Globally the interest in high yield is strong, and 20% of deals in green bonds are sub-investment grade.
Michael Momdjian: We are focused on sustainability, in addition to diversifying our funding sources and investor base. The possibility of issuing a green bond in the global debt capital markets is attractive to Sydney Airport as its delivers on these objectives in a single transaction.
Harald Eikeland: Returning to the topic of pricing, where do investors see pricing trends going? Right now we are issuing on the curve and prices are tightening in the secondary market. Do you see a time when primary deals might price tighter than the curve?
Grow: At the moment primary deals are still pricing on the curve. We have walked away from a few small green bond deals that were trying to price inside the curve because we want an economic return and we are not going to pay more for green at this stage. There is a disconnect between primary and secondary, where secondary pricing is enhanced by the scarcity factor.
Gorridge: Pricing can certainly tighten when there are new investors entering the books. Investa Office Fund’s deal in March was three times oversubscribed and we upsized the deal from A$100 million to A$150 million. Looking into the future, there may come a time when issuing a green bond is the norm and vanilla bonds for high-carbon assets attract a premium.
Grow: Yes, it could certainly go that way, where issuers pay a credit premium if they can’t show any ESG credentials. Investors will be asking for a higher return to cover the inherent risk in a deal that isn’t carbon sensitive.
Kidney: The global pricing story looks flat because there aren’t a lot of direct comparisons, though we know that every green bond tightens in the secondary market. In fact hedge funds are starting to take an interest in the market – buying new deals and selling the bonds after a few weeks when the price improves. Anecdotally treasurers in the A to BBB space who are issuing in US dollars and euro are reporting that they are achieving a price benefit of between 2 and 8 basis points against traditional bonds. Pricing dynamics will change as more investors pour into the asset class.
FA: So where are the capacity constraints in the market?
Kidney: In supply. We need more issuers to come to market representing all sectors – from governments and semis to corporates and financial institutions.
Grow: We want to see more names come to market like TCorp and AGL. These are blue-chip issuers who we have been funding for a long time, and now we want to fund their low-carbon activities specifically either by rebadging existing projects green or by financing new green projects. The latter can send a good signalling message to our stakeholders.
Gorridge: We have enough low carbon assets to continue to issue in this market and the constraints are often an issue of timing in our overall capital management strategy along with the make-up of our debt sources. Not all of our debt is fixed; we also have revolving facilities.
Dann: At QTC we are very aware of our position as a highly liquid Australian semi-government issuer and that our investors value the liquidity of QTC bonds. We don’t want to cannibalise our traditional funding, however, in theory, we could assess any bond issuance and decide whether to issue green.