IFR Asia: SLB and sustainability-linked loan issuance has gone through a lot of growth in the last couple of years and they are particularly popular in Asia. But terms are far from standardised. Alvin, do you see any flavour of SLBs aligned to any mechanism that is going to be popular?
Alvin Yeo: First, we need to differentiate between an SLB and an SLL. There are some fundamental differences.
For SLBs, we should look at it from the perspective of both the investor as well as the issuer.
You need to recognise that investors are not always going to favour a structure where they get an increased return in the event the issuer does not meet its targets. This may seem counterintuitive – if investors get more from a coupon step-up, then they should be happy. But, with this product, that is not the case.
Take fund managers, for example. How would stakeholders react if a fund manager bought a bond on the basis that the issuer is committed towards meeting its targets but, at the end of the day it fails to do so? Fund managers profiting from an issuer’s poor performance does not look good. It’s one dilemma to think through.
Likewise, bank treasury investors may have issues with accounting treatment for bonds where the interest rates could fluctuate, such as in the case of the SLB if the penalty mechanism involves a coupon step-up.
From the investor’s perspective the structure also needs to make sense which means they need to understand the rationale of why the issuer is issuing in this format.
There are also differences in thinking across different type of borrowers. Some family-owned businesses want to do well in terms of sustainability; they have a strong commitment towards the alignment of the ESG targets against the financing strategies. But, at the same time, they may struggle with the position that investors would benefit financially if the firm cannot meet its ESG targets.
Satisfying these different approaches is fundamental in determining the choice of structure of a SLB. And, as such, I don’t think that there is going to be a market standard for SLBs in the near term.
At the end of the day, each structure is going to be determined by answering the key questions: why am I doing this deal? What sort of message do I want to send to investors? And what sort of investors do I want to target?
As an issuer, if I’m targeting a bank treasury desk then I need to know that the structure of any deal is right for them. I may want to consider a different format where the financial penalty goes towards, say, the purchase of carbon offsets, renewable energy credits or even funding climate change research.
Issuers need to think about these things. They need to be confident that when they go to investors, they can say: this is why I’m doing this deal, and this is why I choose this structure.
SLLs are more privately negotiated between the lender and the borrower, so there is more room to discuss the kind of considerations I’ve talked about. But, essentially, there’s more flexibility in terms of coupon step-up, coupon step-downs, and choice of target.
Edmund Leong: It’s very difficult to have a one size fits all structure for SLBs – it really depends on how investors perceive the targets. For example, when we did a deal for Nanyang Technological University, the penalty for not hitting the targets was not a coupon step-up but a one-off 50bp flat contribution into additional climate research and technologies on climate change mitigation, or to buy renewable energy certificates or certified carbon offsets.
SLLS are more customised. We can get into a bit more granularity with issuers in terms of choosing SPTs and providing incentives to borrowers should they overachieve. We have seen coupon step-downs, for instance, which effectively provide a financial incentive for the borrower to hit its targets.
IFR Asia: There’s no single global standard for ESG bonds and loans. Harsha, what kind of challenge does that create for emerging markets?
Harsha Bangari: That’s a good question, especially for India. The key challenges for ESG bonds and loans continue to be disclosure, accountability and taxonomy of green. While I agree that there’s an increasing need for harmonising sustainability standards, a one-size-fits-all approach, in my mind, cannot be adopted immediately, particularly for emerging markets.
In emerging markets, the focus is more towards transition or mitigation and is more localised. The process also depends on the country’s position along the economic development curve.
Most importantly, we need to understand that the price of some technologies makes ESG investments non-viable, particularly in emerging economies. There is a need to strengthen policy in terms of making such technology affordable. India’s progress in the solar energy space is a classic example of strengthening the overall ecosystem and reducing costs.
So, while we should have harmonisation standards, I think a little bit of flexibility would be welcome given the transition most emerging economies are going through. That would also encourage these economies to move towards the final goal of sustainability.
IFR Asia: Daming, how are Chinese standards around ESG financing developing?
Daming Cheng: I can see three features when talking about Chinese standards. First, there is increasing uniformity. In China, we have two bond markets: the exchange bond market and the interbank bond market.
In the past, we had different standards for the two markets and that presented difficulties for issuers and investors. But in 2021, the PBoC published a taxonomy that will unify green bond standards and definitions across the whole Chinese bond market.
That was a particularly important milestone for the development of the Chinese green bond market.
The second feature comes from the international connection. We are seeing stronger international flows as the Chinese capital markets open up. There is increasing interest from international investors in buying domestic Chinese bonds. Last year, they bought Rmb3trn of Chinese Government Bonds, for example.
As the Chinese domestic bond market internationalises, it is essential for us to coordinate green bond standards in China with those in the rest of the world. We are making step by step progress. For example, at the end of last year we published what we call a common ground taxonomy, which provided a link between the PBoC’s taxonomy in China with that in Europe. Finding common ground between these two taxonomies means only one certification is needed to satisfy the requirements of both Chinese and European markets.
The third feature is acknowledgement. Previously, green bond issuers and listed companies found providing ESG information disclosure an extra burden to their day-to-day business. But now more and more businesses, especially frequent issuers and sophisticated issuers in the Chinese bond market, have already established their framework for green bonds, their framework for ESG and they are ready in their day-to-day operations to disclose ESG information. The ESG concept in China has been recognised and accepted.
Dafei Huang: Finding a consensus on how ESG investing is quantifiable, credible, comparable, and verifiable is vitally important in transitioning towards greater transparency.
IFR Asia: In the onshore market in China, Dafei, I understand that there are some quite innovative instruments related to the carbon market.
Dafei Huang: Yes, that’s true. China’s national carbon market launched last year and created quite a lot of excitement. The market covers over 2,100 power generators and over 4 billion tons of CO2 emissions per year. The market is already massive and it’s only going to get bigger by 2025.
There will be an offset scheme with carbon credits supporting the generation of green projects. Carbon pricing introduces direct incentives to industries and companies to improve carbon intensity.
Companies with poor carbon performance will face either a penalty or additional carbon costs – and, eventually, challenges in accessing finance. For example, financiers and investors will start to use the carbon price to assess a company’s climate transition risk in their investment decision making.
Those companies with a good carbon performance will be able to improve their financing with surplus carbon assets and an expanded range of instruments. For example, industries are already being helped to securitise future carbon revenue and are launching carbon-backed loans. The carbon market also creates opportunities for carbon-linked bonds.
Carbon-linked bonds provide a very innovative structure, whereby the coupon consists of both a fixed rate and a floating rate based on carbon revenue. The fixed rate will be lower than conventional bonds with a similar maturity.
Buying carbon-linked bonds can also help investors support the development of green projects, so there’s a social element to the instrument as well.
This type of bond is useful for companies with eligible green assets, such as forestry, and renewable projects. Energy intensive industries may also take advantage of this structure by using their surplus carbon allowance to finance transition plans.
IFR Asia: Julian, what kind of questions are investors asking about ESG? Whether related to a particular bond issue or about the company in general.
Julian Lee: Investors are most interested in your strategy and model. They expect certain standards to be followed but there will be some grey areas, such as to what extent your business can influence Scope 3 emissions. We found that having non-deal roadshows with influential ESG investors was helpful. It’s also important to have dialogue with the ESG community, the agencies and other participants.
Dialogue with the community and investors is important because they will be able to tell you what they need, tell you the direction you should take, and they will understand some of the subtleties. Ongoing discussion and making that extra effort to communicate is key.
IFR Asia: Eugene, what kind of questions are investors asking Sembcorp? We should mention that Temasek is a significant shareholder and they’ve got their own approach to sustainability, so how does that influence Sembcorp?
Eugene Cheng: Disclosure is getting increasingly technical, with GRI (Global Reporting Initiative), SASB (Sustainability Accounting Standards Board), TCFD (Task Force on Climate-Related Financial Disclosures), etc. That poses a lot of challenges for issuers because we have to navigate these new challenges. I’m not sure if the broader investor community find all of this information useful. One question that I always pose to investors is: how do you use the information that has been demanded of us?
From an investor’s point of view – and we’re talking about the full set of investors: portfolio managers, investment analysts, bond funds and equity funds, they want to know how we hope to achieve our targets.
Being able to articulate how we plan to execute against targets is important. This means giving our investors clarity on the markets we will be focused on, how we intend to secure the project, greenfield sites, and any activities, partnerships, as well as how we plan to fund them.
Publishing decarbonisation targets is one thing but producing clear transition plans and commitments on how to achieve them is another. Investors want to see that there is also a clear strategy on how we’re going to execute.
The point is that the dynamic within investors has changed dramatically over the past couple of years.
Internal ESG departments in many funds have grown substantially to the extent where portfolio managers can no longer justify what looks like an economically viable investment through a checklist approach. So, very often, investor meetings involve both the portfolio managers and ESG departments to discuss external contemporaneous environmental, social and government issues.
Investors demand clarity in terms of being able to execute against the strategy and targets we have published. They want to see us being able to live up to what we say and to demonstrate our progress.
Temasek has a clear focus on sustainability. They have set a net zero target to achieve by 2050 and pledged to halve their entire portfolio’s greenhouse gas emissions relative to 2010 baselines. Their ambitious sustainability targets and endeavours have inspired us to be aligned with them.
IFR Asia: Harsha, what kind of questions are investors asking about ESG, both through India Exim’s status as an issuer and in the way that it employs its proceeds?
Harsha Bangari: Being a financial institution, our issuing structures are typically linked to use of proceeds.
During most of our investor engagement exercises most questions are around disclosures – the more disclosure requirements we meet, the more comfortable they are.
As regards use of proceeds, again, the discussions revolve around how, as an institution, we are factoring in accountability to the end use of the proceeds from this type of bond issuance.
Investor engagement has prompted the decision for us to set up our ESG framework and get it reviewed by a second party. We will have an ESG framework that is confirmed by Sustainalytics as being ‘credible and impactful’ and is aligned with sustainability bond guidelines, green bond principles, and social bond principles for bonds and green loan principles and social loan principles for loans.
This document then becomes the basis for an institution’s commitment to an ESG compliant strategy. Having the framework makes our discussions with investors easier. Over time, we will become much better in communicating how are we going to realise our ambitions, the level of our commitment and what type of assets we are developing.
We are like a policy bank for the government of India, and we are engaged in providing finance for infrastructure and social projects outside of India. So, again, lots of questions on how we monitor projects or how we get foreign governments, which are sovereigns in themselves, to align to the whole framework in which Exim Bank believes.
IFR Asia: Not all deals we see in Asia are going to meet the high standards of the issuers we’ve got here today. So, Edmund, what are the risks that some companies could use the ESG label for greenwashing?
Edmund Leong: It’s an increasing risk for banks. It’s mitigated with enhanced diligence in terms of client selection, ensuring that issuers adhere to having done their own due diligence, and making sure there is adequate reporting, disclosure and compliance with use of proceeds – or any other structure they have chosen. That is extremely important.
The key is for issuers to work with good ESG advisers and good bankers who essentially set up targets that are achievable yet challenging. That ensures they have a concrete roadmap towards reaching their sustainability targets.
Issuers will soon realise that failure to use proceeds correctly, or if they breach targets, that doing so would have implications for future market access. That may not just affect them from a debt perspective but would negatively impact relationships with equity investors and bank lenders. It would impact the entire capital structure.
From a UOB standpoint, apart from seeking approvals from underwriting committee for our transactions, we also have an ESG committee that will ensure the issuer adheres to the promised standards. Enhanced diligence should hopefully reduce the risk of greenwashing.
Alvin Yeo: I fully agree with Edmund from the perspective of banks underwriting a bond or loan.
Looking at it from the lens of an issuer, you could break down the risk of greenwashing into quite a few segments. First, an issuer needs to be aware of the most material ESG risks that relate to their sector, the risks specific to a particular company’s profile and its position in the industry.
The second part is environmental controversies. These may be out of an issuer’s control, but sometimes they happen. It doesn’t always mean that the company is responsible for the controversy or that it is not living up to its commitments, but it then becomes a question of how the company deals with it. How did they mitigate the consequences of the event and how do they put systems in place to ensure it does not happen in the future?
Investors understand that sometimes something bad can happen, but they will want to see how the company moves on. That speaks a lot about the management team.
The last point is about perception. Perception has more to do with when you embark on sustainable finance transactions. Investors and market participants form views on the management’s intention for doing this deal, and whether it is aligned with the issuer’s ESG strategy and philosophy at the corporate level – this is really the bedrock of what we have been discussing so far.
The choice of green, social, or sustainability-linked is all about how issuers think about the rationale behind the issuance and how investors connect this with the strategy. It all has to make sense.
Julian has articulated why he took such a long time to figure out the best way to do his deal and Eugene also talked a lot about the efforts to structure the deal from a ESG perspective to align with the expectations of the strategic investor. All of this goes back to why are we doing this and whether the market thinks it makes sense.
As bankers, interacting with management is most important, because it’s the commitment of management to do what they commit to that is key to safeguarding against greenwashing.
IFR Asia: Are there any countries or industry sectors that are expected to be big borrowers in ESG formats this year? Daming, what are you seeing in China?
Daming Cheng: Due to the Chinese carbon neutrality goal we expect a huge amount of issuance to 2060. We estimate that the green investment required is up to around Rmb130trn. That’s a massive investment.
Last year, some Rmb1.5trn was invested in clean energy and in carbon emission reductions. The electricity power sector invested up to Rmb1trn for instance across energy storage, grid improvement and clean power generation.
In 2022, even more investment will be made and based on our estimation, the total amount of clean green investment will rise to Rmb1.8trn.
ESG financing instruments will play a very important role along the way.
IFR Asia: Alvin, what do you see as the pipeline for ESG instruments this year?
Alvin Yeo: So far in 2022, we have seen roughly US$30bn of issuance in the offshore international bond markets across green, social, sustainability and sustainability-linked bonds. About 60% of this issuance is coming from Greater China. A lot of it is from the Chinese banks. Another interesting trend is the local government financing vehicles in China. They are very active in the offshore bond market, issuing green bonds in recent weeks as well.
If you try to extrapolate this trend, basically the Chinese banks plus local government financing vehicles, you come to the conclusion that this is really a reflection of the 2060 policy push in China where China is looking for carbon emissions to peak in 2030 and then for the country to achieve carbon neutrality by 2060.
Elsewhere in the region, you also see banks and corporates from South Korea being quite active. They have issued north of US$6bn so far and it’s a good mix between corporates as well as financial institutions.
For the rest of the year, I would put money on renewable energy companies appearing in the market. There’s a similar theme as to that outlined by Daming, but they may emerge from South-East Asia as well as, potentially, India.
We could probably do with market conditions improving a bit, but Asian sovereign borrowers will remain very active for the rest of the year as they continue to push sustainable finance, setting benchmarks for borrowers in their countries.
The domestic local currency bond markets are also super active for ESG-labelled issuance.
We will continue to see a lot of deals from different issuers across the credit spectrum.
IFR Asia: Edmund, what are the key factors influencing the ‘greenium’ of a bond?’
Edmund Leong: It is very much market-driven in terms of the level of demand on the day of pricing itself and on market sentiment, to be honest. The other aspect is scarcity of supply.
For example, if a well-respected issuer launches an inaugural deal, then, by definition, the scarcity of supply in its ESG paper would affect the size of its greenium.
Another aspect is size. If the issuer is disciplined enough to set a benchmark rather than go for maximum size, then it could affect pricing tension to its own benefit.
IFR Asia: Harsha, how is India going to get to the net zero target by 2070? Are there any strategies or policies that will help India get there?
Harsha Bangari: I will not speak on behalf of the Government of India but as I mentioned earlier, the country has committed to achieve net zero by 2070 and requires US$10trn of investment to realise it.
We have seen a massive surge in ESG issuance over the last two years – around US$1.3bn in 2020 to US$9.4bn in 2021.
The budget speech of 2022/23 states that India would soon begin issuing sovereign green bonds for funding public infrastructure projects in order to decarbonise the economy. The potential for a green bond issuance does underline the intent of the government in this direction. Issuing an Indian sovereign green bond could also catalyse more Indian corporate green issuances, adding to the pool of global green bond investments. In any case, any deal will be subject to favourable market conditions, and they are not that favourable now.
For the net zero target of 2070, there are targets in place to track progress. The intent is there, and we are taking all necessary steps in that direction.
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