A different future
Italian power company Enel’s year highlights the rapid evolution of sustainable financing markets in 2019 as ESG went mainstream, starting with a green bond and concluding with the first sustainability-linked bonds. For making a difficult developmental leap look easy, Enel is IFR’s ESG Issuer of the Year.
Enel has been a longstanding advocate of the green bond market, having raised €3.5bn in the format in the last three years, but it took a big, innovative and highly controversial step by issuing the first sustainability-linked US dollar and euro-denominated bonds (and the first sustainability-linked cross-currency swap) in September and October.
The sustainability-linked bonds included a 25bp step-up mechanism linked to the UN’s Sustainable Development Goals, in a move that directly connected Enel’s business and cost of capital to its progress on environmental goals.
That sent a strong signal to the market about Enel’s commitment to sustainability, from its top management down, as it moves towards carbon neutrality by 2050. The high profile of the widely debated deal also raised the profile of the SDGs in investment banking and beyond, and created a blueprint for other borrowers to use.
It also raised big philosophical issues by expanding sustainable financing beyond the green bond market’s tight “use of proceeds” principle to a potentially wider universe of companies by directly linking borrowers’ sustainability strategies to their funding.
“Enel was a brave trade,” said Frederic Zorsi, global head of primary markets at BNP Paribas. “We wanted to show the market and investors that all companies can link to SDGs, and it’s not limited to use of proceeds. It’s such a game changer; that, for me, is the innovation of the year and the most important deal of the year.”
Proponents argue the structure improves companies’ accountability by linking corporate social responsibility programmes to the SDGs by setting ambitious key performance indicators to accelerate progress.
They also hope that by allowing more companies to raise sustainability-linked deals for “general corporate purposes” the structure creates a framework to scale up sustainable financing beyond its current level of 2% of global fixed income issuance.
Green bond volume is expected to hit US$250bn in 2019, but Enel’s transaction paves the way for more rapid growth by decoupling sustainable financing from a project-based green bond approach to a more strategic corporate approach, aided by a pricing step-up that can motivate companies to accelerate change.
Sustainability-linked deals have already been embraced by the private loan market, where more than US$100bn has been issued this year but extending the structure into the public bond market proved far more controversial.
Enel attracted criticism that it was abandoning its green bond programme and was essentially seeking to profit or benefit from its previously announced goal to move to 55% renewable energy capacity by December 31, 2021, from 46% currently, in line with its November 2018 strategic plan.
“This is not going against the green bond market, but trying to complement it as much as possible with sustainable finance,” said Alessandro Canta, Enel’s head of finance and insurance.
WHAT A YEAR
Enel started a busy year issuing a €1bn six-year green bond in January, its third green bond issue. Orders hit €4.2bn before the deal was priced at mid-swaps plus 135bp, with orders dropping to €3bn. It printed wide of Enel’s non-green Eurobonds but was soon trading inside the curve.
Work on the sustainability-linked bonds began in June, when Enel went to the US to talk to at least seven large US investors after running the idea past its lead banks. US funds have broader ESG mandates and were deemed to be more open-minded to new structures than their European counterparts.
Enel wanted to borrow for general corporate purposes in order to finance shutting coal plants and to invest in better technology to digitalise its conventional power stations, distribution network and storage systems to reduce pollution and improve efficiency – neither of which did not meet strict green investors’ criteria.
US funds, however, liked the idea of an issuer that was willing to put its money where its mouth is and back its commitments with a coupon step-up.
“We were able to explain to investors that when it comes to use of proceeds, they have the same certainty over the utilisation of funds as green bond investing in a serious company that’s devoted all of its capex to sustainability,” Canta said.
Enel priced a US$1.5bn, five-year sustainability-linked bond on September 5 at 125bp over Treasuries, 25bp tighter than initial guidance.
Green bond investors protested, and some purists walked away, but after vigorous debate, many big accounts, including Amundi and APG, got on board with the new structure.
The order book hit US$4bn. Enel said the bonds priced around 20bp inside its conventional bonds and that around 90% of allocations went to sustainable investors.
Canta said the 25bp step-up was in part designed to compensate investors for having to sell the bonds in the event Enel missed its targets.
“Enel took a step that no-one’s taken before – putting a commitment covenant in bond documentation,” said Gaurav Mathur, a managing director at Goldman Sachs.
Enel followed up the success of its US dollar deal with a €2.5bn triple-tranche bond in October using a very similar structure that priced with zero to minimal concessions and raised a €10bn order book. A €1bn June 2024 tranche priced at 55bp over swaps, 25bp inside the wide end of IPTs. A €1bn June 2027 came at plus 68bp, 27bp tighter than IPTs and a €500m October 2034 note priced at 103bp, also 27bp inside.
The bonds had the same 25bp coupon step-up if Enel fails to increase its renewable capacity to 55% by 2021 for the shorter-dated bonds, and misses a 70% cut in CO2 emissions for the 15-year. The company estimated that it had saved around 10bp by doing a sustainable bond rather than a conventional one.
The two deals were hailed by many as milestones in the evolution of sustainable fixed income investment, thanks to their use of SDGs as a framework to measure and report environmental efforts, and the fact that Enel has shown how to turn such bonds into powerful investment tools.
For Enel, sustainability is also good business, which it ultimately expects to be reflected in its cost of capital and ratings, as sustainable companies with longer and more stable futures reap the rewards of transparency and investor confidence that they will be around to repay their debt.
“The objective is first to show the market that if you are sustainable you are a more profitable than risky company and you will have a lower cost of debt. This will further incentivise other companies to be more sustainable,” Canta said.
The effects of Enel’s deal are already being felt around the world as more companies start to discuss the structure and talk to top management about embedding KPIs in their corporate strategies, which will also encourage them to bring capex forward to achieve margin reductions.
Referring to the first deal, Mathur said: “It’s rare to see one single transaction in the capital markets have such an impact on so many constituents. I think a lot of people will view this as a catalyst, not only on the way that issuers structure a bond, but the impact that it’s had in accelerating the ESG dialogue and efforts.”
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