Below trend growth to continue
Companies that need to adapt and transition to lower carbon and more sustainable growth are tapping into a range of new sustainability-linked debt offerings to help finance this transition.
Capital markets play a critical role in the transition to a lower carbon economy, by enabling an efficient flow of financing from investors to issuers looking to address climate risks.
While green and social finance has dominated bond market issuance, transition finance has emerged more recently to provide a pathway “between brown or light green and green” — that is, to provide the financial support to help companies in carbon intensive and hard to abate industries to move towards more sustainable growth and net zero emissions.
Capital markets have been quick to develop new instruments to fulfil this need, ranging from transition bonds to sustainability-linked loans (SLLs) and sustainability- linked bonds (SLBs). These incentivise the issuer to meet pre-defined sustainability targets such as reducing emissions, investing in new renewable generation or technology to reduce emissions in energy intensive industries, or improve sustainability performance more broadly through improvement of externally derived sustainability ratings.
“We have an important role in influencing change for our customers and the suppliers of electricity to our customers,” Michael Bradburn, Chief Financial Officer at Ausgrid, told a panel at the KangaNews Sustainable Debt Summit. Ausgrid, an electricity distributor with almost half the customer connections in New South Wales, is trialling new technology such as community batteries, where solar customers share a battery owned by Ausgrid, making battery storage more accessible.
“It’s important as an issuer that we strive to be a leader and drive change in these areas. As the size of the investor group grows and the importance of these issues grows for them, we want to ensure we stay ahead of the curve.
“But we are not driving this change just because financiers want it; we’re doing it because it’s good business and our customers want it,” Bradburn said.
Investor demand has been key in driving the growth of green, social and sustainable debt over the past five years. For the first nine months of 2020, total green, social and sustainability bond issuance stood at US$360.9bn, higher than the US$326bn issued throughout all of 2019[i].
A range of investor groups have come together to drive lending aligned with the goals of the Paris Agreement, including the Investor Group on Climate Change, the Climate Action Alliance, the Climate League of 16 Australian institutional investors and the UN-convened Net Zero Asset Owner Alliance, whose members have US$5 trillion in assets under management.
Asset manager IFM Investors has worked closely with several companies in high-carbon sectors, which are also known as “hard-to-abate” because making meaningful reductions in emissions will require significant investment and technological change, such as ports and airports.
“Action is critical. Even if you are in a hard-to-abate sector you still need to make progressive moves towards that goal of setting emission reduction targets, and we work collaboratively with companies both on the debt and the equity side,” said Chris Newton, Executive Director, Responsible Investments at IFM. IFM recently committed to reducing greenhouse gas emissions across its asset classes targeting net zero by 2050.
Newton said in structuring its investment portfolios, IFM strongly believes that company strategy should drive financing opportunities, and not the other way around.
“As a fund we prefer the incentive-based structures if there are genuine outcomes a company is delivering, we think that is a better way to look at things as opposed to penalties. We look at the broader structure of a business, and if they are well positioned to survive and thrive in a low carbon economy, that debt is more pleasing,” he said.
That perspective echoes comments by former Bank of England Governor Mark Carney that the transition to a lower carbon economy will prompt reassessments of the values of virtually every financial asset. “Firms that align their business models to the transition to a net zero world will be rewarded handsomely. Those that fail to adapt will cease to exist,” Carney said in late 2019[ii].
Sydney Airport found that delivering two firsts across the sustainable debt market – a A$600 million US Private Placement bond which included a 20-year A$100 million Sustainability Linked Bond tranche, and a A$1.4 billion SLL across 3, 4 and 5-year tenors – required some investor education, particularly in the US Private Placement market where its bond was a world first. NAB acted as joint lead agent and joint ESG structuring agent.
“The pricing discount or premium on the SLL and the SLB are helpful, but the financial carrot or stick aren’t nearly as important as the behavioural change they incentivise,” said Michael Momdjian, General Manager, Treasury, Tax and Insurance at Sydney Airport.
“The ability for our SLL and SLB to help accelerate the implementation of existing sustainability initiatives, encourage the generation of new sustainability initiatives and curb any deterioration
in sustainability performance was key,” he said.
A common topic across sustainable finance conferences, the question of “greenwashing” was put to the panel and whether some recent issues of sustainability-linked and transition instruments have been insufficiently rigorous and may not align to the Paris Agreement emissions goals.
Panellists agreed that clearer standards and principles from industry bodies would help prevent sustainability improvement targets from sliding in bilateral sustainability-linked loan arrangements. Third-party assurance providers have added credibility in assessing an issuer’s sustainability strategy and alignment with their transition or sustainability linked financing frameworks.
“What is more important is that you embed sustainability in the DNA of the company, in its principles and strategy. It shouldn’t be limited to single (debt) products,” said Ausgrid’s Bradburn.
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