Labelled issuance seeks traction in Australian credit

Since then, Australian labelled bond issuance in the credit sector has flattered to deceive. There is regular if not overwhelming supply of green, social and sustainability (GSS) bonds from corporate borrowers in the domestic market but very little from the bank sector. The big-four banks have absented themselves from the local labelled market: while all the majors had debuted by 2017 there has not been a new transaction since September 2021 and just two have priced in the past seven years.

Use-of-proceeds (UOP) bonds were always likely to be a format that suited some issuers more than others. But the failure of the sustainability-linked bond (SLB) – at least so far – to provide a generally accepted transition finance instrument has stymied corporate bond supply even as the sustainability-linked loan format has grown.

SLB issuance had a promising start in Australia with A$2.3 billion (US$1.5 billion) priced across four deals in 2021. But just A$500 million has come to market since then and the product appears to be cast adrift on a sea of questions about comparability, ambition, disclosure and standards.

The situation is certainly not entirely negative, however. Issuers that have maintained supply into the labelled market say demand signals are consistent and clear. Corporate and financial borrowers that have been able to make GSS supply a mainstay of their funding programmes – either because most or all of their issuance can be labelled or because their tasks are sufficiently large that they can maintain consistent supply of labelled and vanilla bonds – say the market is a valuable source of sticky liquidity.

There is no single reason why labelled bond issuance has not reached greater heights in Australian credit. Instead, it is a clutch of factors, none of them large enough to dissuade issuers in and of themselves but sufficient in aggregate to act as a barrier to entry.

The bad news for sector advocates is that this likely means there is also no single fix that will unlock exponential supply growth. On the other hand, it also suggests there is no impassable barrier. Many market users remain optimistic about the longer-term prospects for labelled bonds and sector evolution may be a case of incremental progress – unlocking access door by door, with each cleared impediment freeing up the path for another group of borrowers.

There is no doubt that the fundamental appeal of issuing labelled securities remains in place. The two primary reasons that have been highlighted by issuers and arrangers over the past decade are the value of aligning financing with issuers’ sustainability initiatives and the ability of labelled instruments to appeal to a wider group of potential investors.

Going back to the early days of GSS bonds in Australia, issuers consistently highlighted the concept of attracting new investors to their debt financing as a leading reason for entering the labelled market.

“There is growing evidence of investors that would already have supported an issuer having larger tickets for labelled bonds, either because they have access to more portfolios or because they are confident there will be pricing and other benefits post-issuance,” says David Jenkins, head of sustainable finance at NAB in Sydney. “There is definitely no struggle for demand for labelled sustainable debt – it is a case of finding credible, repeat issuers prepared to put in the work to establish a programme.”

Issuers agree that incremental demand is one of the main reasons to develop a GSS framework. This can be a difference maker for issuers with substantial funding needs. For instance, Fiona Trigona, Sydney-based executive general manager and group treasurer at NBN Co, says she was not entirely confident that the issuer would be able to repay its A$19.5 billion Commonwealth loan without accessing the European market – and “the best way to access funds was going to be in green-bond format, where NBN’s sustainability initiatives would align with European investor expectations”.

NBN has issued around A$6 billion equivalent of green bonds since it priced its first such deal, in April 2022. The domestic market has played a significant but secondary role, as the venue for A$1.7 billion of supply in two transactions – including the issuer’s first. The balance went to the euro market despite NBN only printing its first euro green bond in March 2023.

Issuers say there is incremental demand in Australian dollars, however. New Zealand’s Contact Energy offered a green bond in its first foray into the Australian market, in November 2023. The issuer’s Wellington-based corporate treasurer, Will Thomson, says doing so made a material difference to interest in the deal.

He tells KangaNews: “When we issued in Australia, we met some investors with a combination of green-debt-only funds and more mainstream ones. In this case we would typically meet two fund managers: one who was interested because we are an infrastructure or an energy credit or because they wanted triple-B exposure, and another that was a specific dark green fund.”

If Contact’s offering satisfied the needs of the green funds – which Thomson acknowledges to be a high bar – the outcome was typically a larger bid. According to Thomson, this could materially increase the ticket size. He concludes: “I am confident that being able to offer a green product increased the size of our book.”

The scale of incremental demand for labelled product in the Australian dollar market remains marginal, however. Market users acknowledge that there may have been some overexuberance when it came to expectations of demand growth in the early years of the GSS market. There are dedicated envionmental, social and governance (ESG) fixed-income funds in Australia and mainstream investors’ level of engagement with sustainability has undoubtedly grown over the past decade. But there has not been a step-change in the volume or proportion of fixed income managed under ‘dark green’ mandates.

For instance, in the most recent Commonwealth Bank of Australia-KangaNews fixed-income investor ESG survey, published in October last year, more than 80 per cent of investors reported that no more than 5 per cent of their fixed-income assets under management (AUM) are subject to “dedicated or specific ESG or impact investment mandates”. Meanwhile, 68 per cent of investors said more than half their AUM are subject to a more general “ESG overlay or similar methodology”.

The demand story for labelled Australian dollar credit product is clearly one of evolution rather than revolution. Jenkins suggests: “With the benefit of hindsight, perhaps any expectation that there would be a completely new pool of dark green and sustainable funds was at least somewhat misguided. What we are seeing is the mainstream asset managers investing across a range of strategies that includes sustainable, while larger investors all have their own ESG-focused screening approaches.”

Trigona adds: “Many Australian dollar investors have traditionally been relatively agnostic about whether we offer a green bond. We have, however, noticed recent changes with more fund managers and super funds focusing on this area. In fact, some may not have bought our deals if they had not been green bonds. We believe this format helps us access incremental funding domestically.”

The demand bottom line is that while issuers clearly do not need to offer labelled securities in order to secure access to finance, there is an incremental benefit – and it is apparent even in a well-bid market. Jenkins tells KangaNews that when it becomes apparent that a GSS book is likely to be oversubscribed, many investors proactively disclose the element of their bid that is destined for sustainable portfolios with the goal of obtaining favourable allocations as a result.

The bond asset class may simply not align with what the bulk of specialist funds are seeking to achieve, though. Katharine Tapley, head of sustainable finance at ANZ in Sydney, suggests bonds may never attract the “most dark green” types of funds, precisely because bond issuance is dominated by established businesses whereas speciality funds are typically seeking opportunities in new green technology that are in the venture capital or early-stage capital-raising space.

Even so, Tapley says there is still plenty of headroom for demand growth. “Investors are realising – and banks have largely already realised – that they need to be involved in financing the transition,” she explains. “Ultimately, what we are experiencing in labelled issuance is perhaps revealing that fixed-income investors are not going to get a wholly pure-play opportunity. They may be closing their opportunity spectrum if that is all they focus on.”

The bottom line, though, is that while there is a clear consensus that there is incremental demand for GSS credit in Australian dollars, the demand picture is not so overwhelming that it compels issuers to come to market. This is perhaps best reflected in the very marginal level of ‘greenium’ such deals attract.

Throughout the history of the local GSS market, issuers have typically been quick to note that achieving a pricing concession is not a primary driver – or even a prerequisite – of issuance. There was, however, also commentary – especially in the early days of the market – that additional demand would gradually coalesce into a pricing benefit for labelled transactions.

Jenkins says labelling a deal can contribute to a positive pricing outcome, adding that the greenium has made itself apparent for more frequent issuers in the form of a smaller new-issue discount or pricing in line with outstanding vanilla debt. At times, he says, GSS primary margins can be inside the curve for high-grade issuers and even for some of the more active credit names.

Trigona, meanwhile, says NBN believes the green-bond format adds to price tension in new issuance and supports good results for the borrower. But she does not believe this goes as far as a negative new-issue concession.

Like-for-like comparison is hard in the Australian market as issuers have not adopted the practice of pricing GSS and vanilla bonds in tandem – an approach that has been tried by some global high-grade names, including the German sovereign. Identifying a greenium, especially one that only accounts for a couple of basis points, becomes a subjective task in these conditions.

By contrast, early green labelled tranches in the Australian securitisation market were offered at differential pricing to identical vanilla notes. FlexiGroup, for instance, priced the green tranche of Australia’s first green-labelled asset-backed securities notes 5 basis points tighter than the otherwise identical unlabelled notes. But the practice has fallen by the wayside and the structured finance market has reverted to like-for-like pricing of labelled and unlabelled tranches.

In a market where demand is supportive but not compelling, the decision to bring a GSS bond has tended to come down to issuers’ own motivations – principally, the desire to align financing with sustainability strategy. But labelled issuance is not a free kick and even dedicated issuers acknowledge the need for organisations to be committed beyond the treasury department.

“Our sustainable bond framework must align with our company policies and the directors need to be very comfortable with what has been agreed. We cannot be in a position where we are potentially liable if we have not delivered on what we said we would,” Trigona comments.

There is also a resourcing issue. As the labelled market has gradually ratcheted up its rigour over the past decade, so the requirements placed on issuers when it comes to demonstrating impact, collecting data and reporting have increased.

Intermediaries say organisations that have successfully achieved internal alignment of various business units around sustainability strategy will be more likely to support labelled issuance and should enjoy a more straightforward path to market. In fact, when alignment and communication within a business are suboptimal, the process of bringing a labelled bond to market might be easier than the treasury team realises.

“We are certainly conscious that a lot of background work needs to be done on things like identifying UOP and then monitoring and reporting on it,” Tapley tells KangaNews. “But we also often get feedback that sustainability teams actually had the requisite information all along and, if anything, relish the opportunity to share it – to have their ‘time in the sun’.”

Issuance volume can also be constrained by an issuer’s quantity of qualifying assets and its ability to credibly incorporate them into a GSS pool. Of the two, intermediaries and issuers agree that it is the latter that is likely having the greatest impact on GSS bond supply. In effect, in many cases issuers have not yet mastered the challenge of robustly scoring their assets and aligning them with sustainable financing.

Asset considerations are a particular challenge to issuers in the bank sector (see box above). On one hand, Australian banks’ balance sheets tend to be heavily weighted toward residential mortgages in a world where emissions data for local dwellings is patchy at best. On the other, even when banks have a supply of assets that might be suitable for funding via labelled instruments – their growing GSS and sustainability-linked loan books, for instance – it has proved hard to bring these assets into labelled bond pools.

Adding to the asset-side considerations is the growing spectre of greenwashing risk. The Australian labelled bond market has tended to adhere to high standards of disclosure and reporting: for instance, almost all GSS issuance claims alignment with the International Capital Market Association (ICMA) Green Bond Principles, Social Bond Principles and Sustainability Bond Guidelines, while the use of second-party opinions and assurance, as well as the delivery of impact reporting, are all the norm.

Even so, in an inherently complex space growing scrutiny has led many market participants to conclude that the safety-first approach means refraining from making claims about products’ sustainability credentials at all. In the absence of a compelling pull factor, it falls to issuers to determine whether labelled product makes sense for them – and greenwashing risk is contributing to many potential borrowers’ conclusion that it does not.

Jenkins says: “There has been a tail-off in volume of issuance, though the green-bond sector has held up well. My suspicion is that this is the product of market volatility in general, but more specifically greenwashing concerns – issuers being somewhat reluctant to go down the labelled route when they perceive there to be a lack of clarity, comparability and regulatory focus for green and sustainability-linked instruments.”

Tapley agrees that the risk of being accused of greenwashing is increasingly front of mind in the issuer community, and that the consequence is often ‘greenhushing’ or the decision not to label.
But she does not believe this is the primary reason GSS credit
supply has been limited.

A positive take on the greenwashing and greenhushing situation is that there is little or no sign of bond issuers skirting the rules or trying to pass off dubious product as having sustainability credentials, at least if things like the prevalence of ICMA Principles alignment is anything to go by. But there is a line beyond which reasonable scrutiny becomes a barrier to entry – and the line may have been crossed for at least some Australian corporate and bank borrowers.

By this point, a prospective issuer has sized up likely incremental demand, alignment with its internal strategy, the time and resources needed to find assets and provide ongoing reporting on them, and greenwashing risk. If – as many have, despite the challenges – it determines that the ledger is in the positive and issuing in GSS format makes sense, it still has to deal with bond issuance market dynamics.

Market conditions can produce structural challenges of their own. In particular, the additional workload that is often involved in bringing a GSS bond – especially for a new issuer in this format – can mean a protracted investor engagement and execution process. This does not lend itself to a nimble funding strategy.

“I suspect many of the corporate names that have priced deals this year have been exploring sustainable-themed issuance or are existing GSS issuers. But when push comes to shove, the ability to come to market quickly in response to conditions has taken precedence. It takes time to get labelled deals right, and for some new issuers the risk of rushing things may have outweighed the desire to do it,” Jenkins suggests.

It is clear that myriad factors feed into issuers’ decisions to bring GSS bond deals. While none is overwhelming, it appears that there is too much weight on the anti side of the scale to produce the type of supply growth that might have been hoped for when the market began. Market users agree that there is no silver bullet, but many suggest that if there is a single factor that could level the equation, it is probably issuers’ internal alignment of sustainability and financing strategy.

With the right internal settings, issuers can build a virtuous circle of regular supply and positive transaction outcomes. Having a sustainability team with a track record of collecting relevant data is important. But perhaps more so is that the treasury team knows the content of and where to find data, that management and board are four-square behind aligning financing with sustainability strategy, and that the company is set up to issue GSS bonds with minimal friction in the execution process.

“Issuers have to think very deeply about starting a green-bond programme because there is ongoing compliance and annual assurance on the programme, and there is a cost to this,” says Thomson at Contact. “Our conclusion was that we couldn’t just do the work as a one-off to get a green bond out there. Joining the club is an ongoing commitment.”

Trigona from NBN adds: “We established our GMTN programme, AMTN programme and sustainability bond framework at the beginning of the A$19.5 billion refinancing task so we could have flexibility to respond to opportunities in the market.”

The programmatic style of issuance is well and good for borrowers with a substantial supply of assets that can be lined up for UOP bond financing. But funding established assets is in some ways the end state of sustainable finance, and far more companies need to borrow to invest in transition rather than to refinance existing green assets. Transition finance also arguably delivers investors the most bang for their buck when it comes to additionality, in other words funding activities that are both positive and new.

In this context, the failure of the sustainability-linked bond market – so far – to provide a widely accepted transition finance option (see adjacent box) might be the biggest single reason why supply of labelled product has not grown further. At the same time, market participants say there are plenty of reasons to keep the faith in labelled issuance for corporate and financial sector borrowers.

One is simply that Australian sustainable debt, even after 10 years, is still far from mature. The transition finance subsector is a good example, in the sense that the primary challenge is that there is as yet no common agreement on things like how to define transition, what a transition instrument should look like and how ambition should be measured.

A significant push factor is also looming. Tapley explains: “The arrival of mandatory disclosures will involve some pain but I also believe it will be a catalyst on the financing side. Sustainability teams and finance teams should be thinking about the positive aspect of mandatory reporting, part of which is that it will produce data and other information that can be used to support labelled finance transactions.”

In particular, Tapley says, mandatory reporting should go a long way to quelling greenwashing concerns – or at least taking greenhushing off the table as a generic response. When companies are required to disclose their relevant data, she suggests, they might as well also derive the benefit of using these data to support sustainable financing.

Jenkins adds: “Mandatory climate reporting is taking a lot of focus at major corporate entities and it has to be a high priority for them. They need to get their houses in order from a sustainability perspective, if they haven’t already. A perfect way to leverage the work they are doing in this area is to deploy it for sustainable-themed financing.”