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Investing in sustainability
ESG has a growing role in fixed income investing
Nick Herbert 20 Sep 2017
 Universities are competitive institutions by nature and the further education sector is synonymous with being at the forefront of development in a variety of disciplines. They are not traditionally known for breaking new ground in terms of financing, however, so it was surprising to some that the first issuer of a sustainability bond conforming to new market-driven guidelines was a university based in Australia.
 
Australian Catholic University (ACU) was quick to take advantage of this new phase in ESG (environment, social and governance) bond standardization when, in July, it issued a A$250 million (US$199 million) 10-year offering via joint lead managers National Australia Bank (NAB) and UBS  at 97bp over mid-swap. It is the first in what is hoped to be an expanded universe of issuers looking to finance green and social projects by tapping a debt market hungry for sustainable assets.
 
Interest in socially responsible and sustainable investment is growing rapidly around the world as fixed-income investors increasingly associate ESG risk with financial risk. That realization has been the driving force behind the political will to address climate change. It is also behind the growth in the green bond market.
 
Key to the acceptance of green bonds into the market has been the efforts to define, standardize, measure and monitor the use of proceeds and the impact they have on climate change.
 
“Our work involves facilitating best practices and industry guidelines for new markets,” says Mushtaq Kapasi, chief representative for  ICMA, Asia Pacific. “Over the history of the green bond market there has been a need for guidance and consistency, and we have played a key role in facilitating this by serving as the Secretariat of the Green Bond Principles (GBP) since 2014.”
 
The GBP helped to ensure that proceeds go to green projects by setting standards for transparency and disclosure for new issues, and recommend independent external assessment and verification processes.
 
There has also been a growing trend to expand the principles to include social projects, which led to this year’s release of the social bond principles (SBP). The sustainability bond guidelines (SBG) are essentially a combination of the two.
 
Investors now have a clear view of what constitutes a green bond and what constitutes a social bond – and by extension a sustainability bond, one which conforms to any combination of the four principles guiding green and those of social bond issuance.
 
“The announcement of the SBPs and SBGs is a recognition of the broader shift we are seeing in the financial markets towards a greater focus on sustainability,” says Jacob Michaelsen, head of sustainable bonds at Nordea. “By introducing separate guidelines ICMA has sought to build on the strength and success of the GBP without confusing the labels.”
 
Issuers that may want to issue green bonds but either can’t identify enough green projects or are active in sectors not necessarily seen as green now have guidelines in place to attract the interest of socially responsible fixed-income investors.
 
Sustainable bonds are not a new concept. Indeed, there are already a number of deals in the market that address green and social issues and classify themselves as sustainable.
 
For instance, North-Rhine Westphalia has issued three series of sustainability bonds since 2014. Ile de France has placed six ‘green and sustainability’ bonds to finance projects that meet both environmental and socially responsible performance criteria. Dutch development bank FMO has issued sustainability bonds that conform to its internal rules for lending against green and inclusive projects.
 
There are also a series of social impact bonds in the market that pay against performance. And they are not traditional fixed-income products in that investors stand to lose out if social cost savings are not achieved.
 
Up until June however, there had been no market consensus as to what constituted a sustainability bond. The intervention of ICMA addresses the confusion around definitions, the lack of consistency and the absence of standardization.
 
“It is an important and timely step by ICMA to provide the market with clarity and guidance,” says Michaelsen. “Standardization is a key focus area for the market at the moment and the recent update is a clear reflection of this.’
 
Serendipity bond guidelines
Timing of the release of the guidelines was opportune for ACU as it was already in the process of preparing a green bond or social bond as they were published.
 
In March, NAB had opened up the social bond market in Australia with its first issue targeting workplace gender equality. The obligation was designed to support institutions’ willingness to invest in Australian organizations that champion women and equality. ACU was one of the organizations included in NAB’s initial portfolio of borrowers.
 
With the internal systems in place to identify assets and meet the required high standards of disclosure necessary to qualify for inclusion in the social bond lending portfolio, the ACU was already a prime candidate to issue social bonds in its own right.
 
Universities are natural candidates to tap into this sector as they tick a number of boxes when it comes to measuring up against the United Nations Social Development Goals – they are in the business of providing education to a gender-neutral student body. But they also manage real-estate assets that could suit the ‘climate action’ and ‘clean energy’ goals.
 
Late last year, another Australian higher education establishment, Monash University, became the first from the education sector to issue a green bond with a US dollar private placement that went towards financing green real-estate on its campus, solar panel installation and LED lighting.
 
ACU also has green real-estate obligations. While it is mainly committing funds towards financing and refinancing the university’s teaching and research expenditures in areas including education and healthcare, funds will also be used to help reduce ACU’s environmental footprint. Investments will be made into campus buildings that are Green Building Council of Australia 5- and 6-star Green Star rated.
 
The inclusion of investments associated with real-estate illustrate the flexibility of the guidelines.
 
“ACU decided to reject the green bond path,” says James Waddell, director, corporate services and ESG at NAB. “But when the Sustainability Bond Guidelines came through it was a perfect opportunity to include the green aspect into a deal.”
 
Nevertheless, the borrower’s social bond thinking was at the forefront of the discussion during roadshows that began in July.
 
“When it came to the use of proceeds, ACU’s focus was on social and then green in that order, rather than green and social,” says Waddell.
 
The deal was launched into a ready investor base, not only due to its inherent rarity value as a non-bank Aa2 rated (Moody’s) issuer, but also coming hot on the heels of NAB’s own Social Bonds. ACU’s deal went into a similar type of investor.
 
Pricing at 97bp over asset swap was impressive since it was equivalent to a standard 10-year bond from one-notch-higher rated University of Technology Sydney (Aa1), which came earlier in the same month.
 
The pricing comparison is not proof that investors will pay a premium for products offering exposure to sustainable assets, but investors are modifying their behaviour. 
 
“There was a high degree of interest in the sustainability angle,” adds Fergus Blackstock, managing director, debt capital, at UBS. “The Australian investor base approach to socially responsible investing is developing – there is a notable direction of travel. There are a few dedicated funds, but many funds have noted increasing demand from their own end investors. Appetite is growing.”
 
That growth in appetite is reflected in the numbers. According to the Responsible Investment Association Australia, responsible investments more than quadrupled over a three-year period to reach A$622 billion in assets under management (AUM) in 2016, with nearly half (44%) of Australia’s assets under management being invested through some form of responsible investment strategy. And of the 10 largest asset managers of core responsible investment portfolios in 2016, all 10 held core fund offerings greater than A$1 billion in AUM.
 
All over Asia?
Similar changes to investor behaviour are emerging through the rest of Asia, and the ACU deal reflected the increasing interest throughout the major centres in the region, with roadshows held in Singapore, Hong Kong and Tokyo. Some 24% of the deal went to Asia, while another 1% went into the hands of European-based investors.
 
The 10-year tenor fits into the investment requirements of Japanese life insurers whereas money managers in Singapore and Hong Kong also took allotments.
 
“ESG mandates throughout the Asian region are increasingly becoming a feature of the investor landscape.  We are seeing a mix of dedicated ESG focused money as well as those more traditional portfolios preferring a layer of sustainable investment. ACU was a perfect example of the diversification and enthusiasm that investors have toward this increasingly interesting sector of the market,” says Tim Galt, head of Asia-Pacific DCM syndicate at UBS.
 
Nevertheless, the development of the investor base and the market in general in Asia is fragmented.
 
“Outside of the more advanced centres in Asia, demand for green and social bonds is still lagging behind Europe and the US,” says Kapasi. “The overall Asian investor base is not nearly as focused on sustainable finance.”
 
Aim to sustain
While, in some ways, Asia is in the forefront of developments in the green bond market, in others it is lagging.
 
China may have been the big global story in 2016 with the introduction of its Green Bond Guidelines and its huge support for green bond issuance levels, but elsewhere in the region, the ‘greening’ progress is less advanced.
 
There is an evident need to raise awareness amongst issuers and investors and action from regulators in order to promote the development of the green, social and sustainability bonds.
 
Efforts are being made, however, to establish the building blocks: Japan introduced its green bond guidelines in March, India in May, Taiwan in June, progress for similar guidelines is underway in Indonesia. The Asean Capital Markets Forum is set to announce its guidelines based on the ICMA Green Bond Principles in September.
 
In Singapore, the Monetary Authority has also introduced a financial incentive to go green by offering to pay for the first external review.
 
And there are plenty of opportunities in the region to spread the word and raise awareness in a host of ESG related conferences and seminars. For example, ICMA is jointly hosting with the Japan Securities Dealers Association a conference in Tokyo in November to discuss the Asian perspective to developments in the green and social bond market.
 
As well as developing the market in the region, Asia needs to play its part globally. Representation on ICMA’s GBP Executive Committee has only recently been addressed with the inclusion of Bank of China to its ranks, for instance. But it remains the sole regional member.
 
There are also claims that investors outside of the region are missing out on the deals from Asia and calls for a more efficient syndication process – one aimed at tapping into dedicated green asset managers in Europe and the US.
 
With demand for green and social bonds currently outstripping supply, tempting the European and the US investors may not be essential at the moment, but they might be a valuable resource of demand in the future.
 
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