KEITH MULLIN, KM CAPITAL MARKETS: THERE’S A LOT OF CHATTER ABOUT GETTING BACK TO NORMAL. ARE WE GOING BACK TO THE ‘OLD NORMAL’ OR HAS THE WORLD MOVED ON? ARE WE GOING, TO USE THE CLICHÉ, TO ‘BUILD BACK BETTER’?
Jörg Boche, Volkswagen: At least from the corporate perspective, we are certainly coming out of the crisis in a different shape to how we went into it. One trend that I’ve observed that has been catalysed, if not started, by the crisis is a significantly stronger move towards vertical integration in industry.
From our perspective, that has two aspects. One is more upstream integration of parts of the value chain, particularly those that are linked to raw materials. The other, due to technological transformation, is the internalisation of technological know-how, which is relevant for things like battery cell production or software. In all these respects, we have learned that the trend of outsourcing everything to a global economy has reached its limits, or is at least showing that there are limits.
There is some value in vertical integration that becomes very clear if you run into a crisis like this. But some of this may actually be linked strongly to the technological transformation that we are going through, regardless of Covid. Covid has catalysed this technological transformation, but I think, in these respects, things are going to be different to what they were before the crisis.
Ingo Nolden, HSBC: One thing I have noticed is how inflationary pressure works through the system. Is it just a temporary blip or is it a more structural shift? Another thing is procurement. Some corporates have a very tough procurement function, both in financial services and in industrial procurement. The question is, can it go on like this? Bearing in mind this question about resilience, will complexity now lead to more flexibility in how companies think about their production chains and about procurement? Maybe they don’t need to focus on the last dime but they do need to focus on striking a balance between cash savings, and reliability across aspects such as quality and delivery. For me, the jury is still out.
I’m a bit sceptical about the, let’s call it, broader wisdom at the moment that this is just a temporary blip in pricing pressure. Maybe there are some aspects where you can save costs in, say, office space. But the issue for a manufacturing company is how cost savings in office space stack up if raw materials costs are going up by 10% year-on-year. At what point do you have to raise prices to stay in the game?
I feel there is a bit more of structural change taking place than financial markets are pricing in at the moment.
Sven Vorstius, Bayer: Maybe I can add a similar idea, which may differ from industry to industry or sector to sector. What we, as part a pharmaceuticals company, are experiencing – if you take the public discussion around pharmaceutical products – is the question about whether we need to produce them in Germany. It’s a valid question that can be seen in other areas too, with more or less impact.
This represents a shift in the public discussion, a complete turnaround to what I have seen in the last decade. I think there are several items where it will be interesting to see if such discussions are just temporary. We’re talking about a lot of structural changes now, but will they go away a year from now, or will it be a real turning point in longer-term developments or strategies? That’s still completely open.
Mirko Gerhold, Commerzbank: On the supply chain, there have been some totally new experiences on the consumer side. For example, people would go to a DIY store to buy, say, a piece of wood. Now they are experiencing for the first time that this is not always possible because there is no stock. On the vaccination side, too, people are not used to waiting to get vaccinated but the vaccines are being produced somewhere else and there is insufficient supply.
I think there will also be some pressure from people, from society and, as a consequence, it will fall to the political side to address those topics, at least to think about whether supply chains need to be adjusted and whether there is a limit to globalisation.
KEITH MULLIN, KM CAPITAL MARKETS: I WANT TO TOUCH ON ANOTHER BIG SUBJECT: ESG. HOW ARE YOU EACH DEALING WITH THIS THEME?
Christian Große Erdmann, Deutsche Bahn: We are trying to position Deutsche Bahn as a “green issuer”. A lot of people consider rail transport as green but we don’t want to rest on this positive assessment. People here really take this topic very seriously. Since I joined the company, my salary has depended on ESG targets, including CO2 reductions. ‘Put your money where your mouth is’ really happens.
And as if it were timed for this event, Deutsche Bahn announced today [the IFR Webinar took place on June 16] that we’re bringing forward our target for being fully climate-neutral by 10 years to 2040. That’s on Scope 1, 2 and 3 emissions, the whole thing. That’s incredible if you consider what it means in real life. It underscores our strategy of positioning Deutsche Bahn as a green issuer. And that’s the key here. We’re talking about being a ‘green issuer’, not necessarily about green bonds.
Our approach has found a lot of support. The Luxembourg Stock Exchange, together with the Climate Bond Initiative, recently launched a new window on the Luxembourg Green Exchange for climate-aligned issuers. We are one of only around 25 European corporates admitted to that. It means that all of our bonds can now be traded on the Luxembourg Green Exchange.
Overall, we’re trying to continue in that direction. We’re extremely good on transparency: there are a lot of numbers available on our overall ESG score, and we’re trying to follow up on points that are not yet perfect. It’s not just about CO2 emissions, it’s a wider thing. For example, there are investors concerned about accidents on construction sites, which impacts their ESG score on us. The key message is we’re positioning ourselves as a green issuer.
KEITH MULLIN, KM CAPITAL MARKETS: ALEX, I’M CONSTANTLY READING ABOUT THE DEMANDS THAT ASSET MANAGERS HAVE FROM CLIENTS TO MAKE THEIR PORTFOLIOS GREEN. CAN YOU PROVIDE SOME THOUGHTS?
Alexander Hirt, Allianz IM: Allianz Investment Management gives mandates to asset managers, so we are the clients who make those demands you mentioned. ESG has been a priority for a number of years. We use ESG scores to identify points for discussion; that’s the weakest 10% per region where the asset manager needs to follow a ‘comply or explain’ approach. There is no automatism but we also look at the overall picture to make sure a company’s overall ESG strategy is on track.
Overall, it’s not about taking exclusionary investment action; it’s about engagement in a way that leads to changes in underlying businesses. Allianz is a founding member of the UN-convened Net-Zero Asset Owner Alliance. This lies at the core of another ESG priority for Allianz: we didn’t only commit to make our investment portfolio carbon-neutral by 2050 but we have also committed to reduce the emissions in our investment portfolio by 25% by 2025. That’s very ambitious.
Our focus is to promote green investments, engage with issuers, and look for financing opportunities that can support transition. Green bonds are an important instrument to help meet this trajectory. Generally speaking, we like these instruments because the projects they finance facilitate more sustainability. But at the same time, we pay close attention to the greenium that green bonds command so the premium is not too detached from the other bonds of the issuer, because ultimately it’s the same company with the same credit risk.
Mirko Gerhold, Commerzbank: This topic is becoming more and more important from a regulatory perspective and for investors. We have already reached the same level of sustainable debt issuance this year as we had for the whole of 2020, almost €400bn-equivalent. If you look at the euro corporate bond market year-to-date, almost 25% of all bonds are sustainable or sustainability-linked. That’s huge, and why this topic is becoming more and more important.
The Green Bond Principles and other sets of standards and principles are an important catalyst to support this growth. Roughly 97% of all outstanding green bonds are in compliance with the principles. That shows how important this market standard is.
From the issuer perspective, this does not necessarily mean that everyone needs to issue a green bond; that will always depend on the individual situation. But what it does mean for every bond issuer is that they need to address the topic and be open about their own situation, policy and sustainability strategy because investors, as Alex mentioned, want to know about it. Investors want to know how sustainable an issuer is as a company in addition to whether bond issues are labelled green or not.
This is certainly the case for us as a bank. We recently announced that we’ve joined the UN-convened Net-Zero Banking Alliance, so we’ve also committed ourselves to reduce the emissions of our lending and credit portfolio by 2050 to net-zero.
KEITH MULLIN, KM CAPITAL MARKETS: MAX, THERE’S A LOT OF TALK ABOUT GREENIUMS AND COMPANIES HAVING TWO CREDIT CURVES FOR SUSTAINABLE AND CONVENTIONAL BONDS. THERE’S ALSO A LOT OF TALK ABOUT GREENWASHING That SOMETIMES IT’S HARD TO KNOW HOW TO GAUGE ESG INSTRUMENTS. THE MARKET HAS GROWN SUBSTANTIALLY IN THE LAST THREE OR FOUR YEARS. WHAT’S YOUR TAKE?
Max Berger, DWS: What really helps is that the volumes keep growing. On the basis that 25% of all issuance has an ESG label or angle to it, issuing a green bond is not so special any more. There’s a lot of discipline coming back into the process. On their inaugural bonds, green bond issuers issued through their curves. That is starting to no longer be the case. That’s good. You had situations where the argument was: ‘I don’t like the company, I don’t like the sector, but the ECB is in the book and it’s a green bond so I’m buying it’. That is no longer the case. Having some discipline back in the process is good.
We like green bonds, we like SRI bonds, we like the movement, and we have dedicated funds for this product. Now that you have a bigger selection of issues to choose from, you can better engage with issuers. We can say: ‘I don’t like your green bond and I have 50 others to choose from so you’ve got to do it right’. That’s very important.
The movement and adoption rates are strong but we feel the market is underestimating some of the impact around implementation across portfolios. If you think about more and more clients applying CO2 filters to their portfolios, if you think about the fact that the ECB might do some greening of its programme, one very important point is that investors are looking at ESG benchmarks, so you are in a situation where maybe big assets are moving against benchmarks that are exclusively based on one sustainability rating provider, creating a bias, one could argue. I think the market is underestimating that.
For us, it means being early and anticipating those trends can be a source of alpha, because that’s also what ESG should be about: enhancing performance.
Ingo Nolden, HSBC: What we need focus on is how we actually reach those targets by 2040–2050. The devil really is in the details. I wouldn’t say it’s an art to buy a renewable energy company and say: ‘Great, I have a green bond’. But what is an art is supporting what is considered a brown or difficult sector, such as the car sector, and helping its transition.
Some sectors can never be CO2-zero; it’s just not possible, according to the experts. For me, the kicker now is to really get the guys to understand but who say: ‘Listen, I cannot send 150,000 people home’, because that is not sustainable either. ESG is not just about E, we have also S and we don’t want to run into huge political pressure.
We all know this is a huge transformation. My question to big investors like AIM or DWS is how can we go to issuers that might have problems. I think the sustainability-linked bond concept is a good one but the questions, as always, lie in the detail. How can we really know if the KPIs are good enough? How do you support the transition of less-green sectors?
Alexander Hirt, Allianz IM: That’s a very important point. That’s what I was trying to address when I said it depends on each company, the plans that a company has, and the engagement we have with that company. Let me give a prominent example at Allianz, and that’s coal policy. Allianz has had a policy towards coal-based business models since 2015. There was a very clear direction that we said those business models should take. For example, no new coal-based power plants and, for existing ones, outline plans on reducing emissions from their businesses.
This policy is a document that’s been there since 2015. It’s been about engaging with the companies affected, opening a dialogue to listen to the things we may be missing and then gradually developing those policy elements and tightening the scope. What I want to emphasise is it’s a dialogue over time. In the case of coal, it started six years ago and will continue year by year. That’s something that we do ourselves as well as through our asset managers. Obviously, the Asset Owner Alliance is very powerful as well.
Max Berger, DWS: The positioning of ESG funds is pretty much based on exclusion lists only. This notion of having a positive list is nice in theory but it’s a challenge in practice. That’s what we’re aiming at. It requires moving away from using simple scores by sustainability ratings agencies and involves combining perspectives from equity and credit, having a multi-asset approach; it involves a lot of engagement.
One anecdote on a situation we had the other day: Plastic packaging is a topical theme. In our universe, there are one or two companies that are very big in plastic packaging so you could take the view: ‘Okay that’s bad. I don’t want to buy into it’. Or you could take an alternative view and say: ‘Okay, if we want to make plastic packaging better, we need these companies’.
You can have the same argument for a lot of sectors. We have a lot of work streams to make this engagement better and buy into those companies in sectors that have an ESG angle but then finding those that can make an impact.
Jörg Boche, Volkswagen: Every company is slightly different in this respect. Coming out of the trauma of the diesel scandal, our CEO and the board changed the company’s strategy in quite a fundamental way to strongly place their bets on electrification and everything to do with that, which was quite radical. For us in the financing division, when you talk about ESG, it made things somewhat easier because we had this huge volume of investment that we could draw on to issue green bonds against. That is going to be a very important part of our funding.
The one thing we all have to work on is documentation and having a transparent and intelligently standardised way of making sure that we are talking about the same thing when we talk about green issues. If you go down to the practical level, we make investments, we buy machinery and use it to build cars or car parts. Sometimes you discover that a certain piece of machinery or development outlay can be used for a car that runs on gasoline as well as an electric car.
In our books, we haven’t so far made the distinction as to whether something is now a piece of green equipment or not. When we started to think about these things, we realised that there was a lot of documentation work to be done to sort those things out, and also engage with ratings agencies to clarify those issues. We even brought in auditors to help us on that.
This dialogue needs to be broadened to investors so that we’re all clear about where we want things to go strategically and what we’re talking about when we say ‘green’. Just saying ‘green bonds’ is almost too abstract. We need to get down to a more concrete level of dialogue between us as issuers and our investors.
Sven Vorstius, Bayer: It’s a big dilemma. What I’ve been hearing for nearly two-and-a-half years is that we need standardisation, we need common KPIs. But if I take the comments today from investors, it’s actually the contrary. It is rather: ‘I need to look at issuers specifically, and need to understand them and see what the mechanics really are. Are they bad for the sector? Are they best in class, from the transition perspective?’.
If I look from a debt issuance perspective, I can issue specific use-of-proceeds bonds. If I look, for example, at Bayer’s business I might carve out certain products. If someone is not a fan of [the herbicide] glyphosate, I can do a use-of-proceeds bond for consumer products or I can do one for glyphosate only, which has just a specific investor buying who appreciates glyphosate’s CO2 balance.
If you dig into the details, you will always find something that you don’t like, which begs the question, where’s the money going finally, and seeking returns. This is very interesting. I agree with the overall movement, the direction and the efforts, but I don’t see a quick solution.
KEITH MULLIN, KM CAPITAL MARKETS: COULD EACH OF YOU MAKE A CLOSING STATEMENT – WHAT ARE YOUR CHALLENGES AND CONCERNS? WHAT OPPORTUNITIES DO YOU SEE? HOW DO YOU READ MARKET SENTIMENT? HOW MUCH FUNDING DO YOU HAVE TO DO? WHAT ARE YOUR BUY-SIDE PRIORITIES?
Ingo Nolden, HSBC: First of all, collectively we have done a good job. Most companies in Germany and the German economy are in good shape, contrary to the last crisis. Banks are in relatively good shape although they have their issues. For me, the biggest challenge will be keeping up momentum, the speed of change in our organisations. This crisis has brought a lot of issues to the surface. Some of the solutions are pretty obvious but it will take time to address them.
I’ve seen my institution change drastically in the last 12 months. It’s a positive dynamic but we also need to wonder whether we can keep up the pace that we have set over the last 12–18 months. There are a lot of moving parts but we have all the right ingredients and I’m looking forward to a positive future. I think we’ve once again shown that we can make the best of difficult situations.
Christian Große Erdmann, Deutsche Bahn: If you see how infection rates are coming down and how passengers are coming back on to trains, I wonder whether all of the multi-billion euro investment programmes will be sufficient for customers to find a seat, especially with the push to sustainable transportation and the pressures from society and businesses to stop flying and take trains instead. This is causing a social demand push from which we and other rail transport companies can hugely benefit.
Our big issue is growing capacity fast enough to cater for this anticipated demand. Generally speaking, that’s an extremely positive story. If demand is there, you just have to scale up supply. And we are working on this in line with our “strong rail” strategy.
On the funding side, there will be more supply from us. We will continue to issue this year and beyond but we are not anticipating major hiccups. [Deutsche Bahn successfully issued a €1bn 30-year bond shortly after the IFR Webinar, the first 30-year bond from a corporate issuer this year]. One thing that I would want to carefully observe is inflation because I see that popping up in different places, and that may impact us all one way or another.
Max Berger, DWS: I’m a credit portfolio manager so let me give you a few words on how we think about the market over the next couple of months. We’re quite constructive. We’re thinking about the technical picture; the supply/demand balance is quite favourable, the fundamental cycle is on a good track to recover, recovering even quicker than we thought. The problem is valuations are too tight so we’re maybe hoping for some volatility around central banks withdrawing stimulus and reducing their programmes as good buying opportunities.
One element we’re thinking about a lot with regard to the next 12 months – post-pandemic, if you will – is that we still have quite limited visibility on some of the structural changes in certain industries. How many business flights will there be? What will office space look like? What is the future of retail and shopping malls? We’re thinking about it but we’ve got to acknowledge the visibility on some of those questions is very limited.
If you think about bonds and credit, you could argue the recovery has already come a long way and [the market] looks quite expensive to us but there are still areas to be conscious about. And lastly, the other side of capital allocation is capex. What is very interesting that we see a bit of a mindset change towards investment and capex. Corporates globally haven’t really invested much in the last 10 years. It’s not only that they’re making up for capex lost during the pandemic; some issuers in sectors are looking at healthy new capex opportunities.
Credit investors would welcome healthy capex rather than stock buybacks or large acquisitions. I found Jörg’s comments about vertical integration and the integration of technology very interesting as themes that could drive a continued change in capex. I’m not too sure if that’s specific or relevant to Germany versus the rest of the world but I think that’s something that makes us quite excited.
Sven Vorstius, Bayer: From Bayer’s perspective, the company is in litigation mode and that is challenging. If I move from that to the funding side, we are in deleveraging mode. I don’t have funding plans to date and for the next 12–18 months we are very comfortable, having done our funding. We have a hybrid call in late 2022, but that is too far away today to really think about any action.
With regard to the overall market, with funding support by central banks, especially in Europe, and the way they’ve acted around some of the measures, I see stable conditions for corporates. A bit less negative interest rates is maybe bad in borrower’s accounts but healthy for the system.
Jörg Boche, Volkswagen: If you ask in 10 years what people thought about the corona crisis, I think they will talk about it more in terms of all the change that it has brought about than what happened during the crisis itself. It strikes me – and I think our discussion nicely reflects my impression – that so many new trends in technology, in finance, in industry, in regulation, in economic policymaking have been set in motion through the impact of corona. It’s almost like the birth of a new regime in many respects. That’s the thought I find most intriguing.
Alexander Hirt, Allianz IM: Every crisis is also an opportunity and it will be interesting to see how those opportunities unfold. Regarding the market environment, we see tight spreads and markets that look more mid-cycle although, economically, we all agree we’re still in an upswing. But in this mid-cycle context spreads are tight. On the other side, companies still have balance sheet repair to be done but, we also see capex and M&A rising. So these are definitely things we are watching as much as inflation.
Let me add something else to think about, and that’s how much central banks have changed the market. It’s undisputed that they helped a lot during the crisis but the question is how much have they changed the market sustainably? Have they capped future spread-widening for future stress periods? Is that something that investors have integrated into their thinking? And maybe, as a consequence of that, have they potentially made investors accept lower spreads? How will the behaviour of central banks in this crisis, which was certainly needed, be integrated into future market functioning? That will be interesting to watch.
Mirko Gerhold, Commerzbank: If we look back to where we stood 12–15 months ago, the situation has significantly improved from the real-world perspective. Hopefully, the Covid crisis will soon come to an end. I think the outlook is very positive for the economy and also for the bond market. The economic recovery should be supportive for credit. Even if we get some tapering in the US and related shorter-term volatility, in the medium term, rates should remain low, which will be positive for the bond market.
I hope that we will be able to preserve some of the lessons learned during the crisis, whatever those are going to be: be it resilience; be it the functioning of the bond market in crisis mode, or be it in supply chains. This is at least one positive thing that we can take from the crisis: to learn from these lessons and make the best of it.
KEITH MULLIN, KM CAPITAL MARKETS: THAT’S A GREAT PLACE TO END OUR CONVERSATION. THANKS TO ALL OF YOU FOR YOUR COMMENTS.
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