AOFM’s green debut achieves greenium but book size fails to excite

Deal volume comfortably matched the A$7 billion (US$4.6 billion) maximum target, but the manner in which the book built has attracted some commentary from the buy side. The book was more than A$20 billion by the first update around midday Sydney time the day before pricing, at price guidance of minus 5 to minus 1 basis points over EFP. This included just less than A$4.5 billion of lead manager interest. At the next update, circulated at the end of the Australian session on 3 June, the book had grown by a further A$5 billion with a price revision to minus 5 to minus 3 basis points over EFP.

KangaNews understands the revised price guidance at update two had the greatest impact on book growth. The first surprise for some investors was the absence of a book update in the early hours of the Sydney session on 4 June. Buy-side sources say they were looking out for book update three and for the latest bookbuild statistics in it.

Marayka Ward, director, fixed income strategy at QIC in Brisbane, says her firm anticipated significant boom growth overnight, particularly given the efforts the arrangers and issuer had put into marketing to offshore investors.

Update three landed on screens at around 9am Sydney time on 4 June. It contained the spread set level – which landed at the wide end of revised guidance of minus 3 basis points over EFP – and confirmation that firm orders were lower than update two, at A$23 billion. Lead manager interest had scaled back, to A$3.3 billion.

David Gallagher, head of Australian fixed income at Artesian Capital Management in Sydney, says he was surprised by the relatively small size of the final book. “I don’t think I was alone in speculating that the AOFM orderbook could have been 10 times the size of the deal,” Gallagher says.

The green-bond debut attracted an incrementally more diverse book than comparable AOFM syndications: 10-year vanilla Treasury bonds issued in recent years have been distributed to an average of roughly 80 unique accounts. The 105 unique investors in the green bond represents an approximately 20-25 per cent pick-up. The green bond was close to 3.3 times oversubscribed, a coverage ratio roughly in line with AOFM syndications in the pandemic era (see table).

Source: Australian Office of Financial Management 6 June 2024

Anna Hughes, the AOFM’s Canberra-based chief executive, says the debt management agency was not expecting a blowout book. She adds: “We were very clear that investors should only bid close to their target volume and that we would be allocating based on price leadership. For some, perhaps, the deal was priced too tightly.”

Overall, leads say, the progress of the book reflects overall price sensitivity rather than a specifically weak response from Europe. Elliot Wolgamot, director, DCM and syndicate at Westpac Institutional Bank in Sydney, characterises European interest as “significant”, adding that there was particularly good support from European and UK real money investors – in line with the level of engagement provided by the AOFM roadshow. He adds that the issuer had good visibility of potential investors from the UK, with several well-known accounts in the region running significant Australian dollar portfolios and global or green mandates.

Lead managers concede that the optics suggest stagnation in the book during European and US hours but say it is inevitable that some bids will reduce or drop out entirely as pricing is revised tighter. Ben Porter, director, debt capital markets at Deutsche Bank in Sydney, tells KangaNews: “We are always mindful that overnight growth may be offset by other accounts leaving the book when there are price revisions involved.”

Specifically, leads say the price revision led some domestic accounts to scale back and some hedge fund interest only to retain orders at the tighter end of the range. “Update three was the net result of some domestic interest reducing after the price revision and the added demand out of Europe,” Wolgamot suggests.

“Investors may have expected the book to keep building in one direction, but after we moved pricing to the left-hand side a number of investors felt there was now less chance of post-deal performance,” adds Nikolaus Romuld, Sydney-based head of bond syndicate and high-grade origination at Commonwealth Bank of Australia.

“A number of domestic investors had expressed price sensitivity so there was some expectation that the book would not retain all this demand once the range was revised tighter,” Porter continues. “Some investors either reduced their interest or dropped out of the orderbook while at the same time some new accounts came in. These accounts were largely real money in Europe, the UK and US, and were allocated quite strongly as a result.”

Pricing and technical factors rather than green credentials seem to have been the primary driver of investor response to the deal. Newton Investment Management uses a whole-of-issuer approach to sustainability and Jon Day, Newton’s London-based global bond manager, tells KangaNews that based on its political system, educational levels and rule of law, as a country Australia fits Newton’s sustainable investing criteria. Even so, pricing was the final determining factor.

Day adds: “There has already been plentiful supply of green and other labelled bonds into Europe and the UK. The AOFM bond was not issued particularly cheap to the curve so the main reason for investing would be to buy a green bond rather than to buy a cheap bond.”

For Lukasz Irisik, senior portfolio manager at Nikko Investment Management in London, it came down to cash flows. Irisik says Nikko undertook a one-on-one presentation with the AOFM having invested in Australian sovereign bonds for many years, and the fund manager remains committed to supporting future issuance.

On this occasion, however, Irisik explains: “Given the limited flows we have recently had to our global bond funds, we didn’t have spare cash to add to this transaction. We hold several semi-government and supranationals around the same maturity and, given their recent underperformance, it made no sense to liquidate to fund the green AOFM issuance. The deal was well oversubscribed and we felt the issuer didn't require additional participation or support from us at this time.”

David Jenkins, Sydney-based global head of sustainable finance at National Australia Bank, says roadshow meetings provided consistently positive feedback on the Australian government green-bond framework, which is aligned with the International Capital Market Association’s Green Bond Principles and has a second party opinion from Sustainalytics.

Jenkins tells KangaNews feedback from global investors is reliably that they are supportive of the AOFM’s approach to the green bond. “Its credibility and alignment to government policy objectives and climate change commitments has left a positive impression, including the way this was articulated and supported through the framework as well as throughout the extensive engagement process,” he says.

On the other hand, the green label may have added complexity for some domestic and offshore investors. Darren Langer, Sydney-based co-head of Australian fixed income at Yarra Capital Management in Sydney, says: “Current scrutiny on greenwashing and the fact that this is the first issue under the AOFM’s green programme might have persuaded some potential investors to wait to see how this issue progresses before committing.”

The margin offered by a green security appears to have added a challenge in a price-sensitive market. Langer says the margin was notably tight, telling KangaNews that based on where the fund manager saw fair value and relative to the issuer’s vanilla curve the theoretical new-issue premium was zero and pricing was tighter than where the AOFM vanilla 10-year line was indicated in secondary.

The May 2034 Australian Commonwealth government bond (ACGB) was marked on rate sheets at around minus 1.5 basis points over EFP and the December 2034 ACGB at 0.5 basis points over EFP prior to the green bond’s launch.

Buy-side sources agree with the deal group that a greenium of 2 basis was incorporated in final pricing.  Deal sources tell KangaNews that acceptance of a greenium has thus far been led by offshore investors. However, with domestic investors ultimately comprising the lion’s share of the book, this suggests a level of comfort not previously seen from domestic fund managers with the greenium concept.

Hughes adds: “Achieving a greenium was never a KPI. Whatever we got, it was always going to be a nice to have."

Ward agrees that the greenium is fair based on the level of work the AOFM carried out with investors and what has been achieved by other labelled bond deals. Although admitting to being slightly surprised that there is a greenium at all – and adding that only time will tell whether it can be maintained in the secondary market – Artesian’s Gallagher says he is cautiously optimistic as he notes the excess demand in the book even if it did not grow in line with some expectations.

He continues: “Considering there is a greenium this tells me the orderbook composition is real and investor appetite for the bonds is legitimate. It is not a massive book, but there is still A$15 billion of unfilled demand and perhaps two-thirds might chase the bond in the secondary market.”

Investors credit the AOFM with a responsible path to market for its debut green bond. Ward says the transaction had among the most thorough lead times the market has seen and consequently allowed QIC to be maximally prepared. She tells KangaNews the AOFM, Commonwealth Treasury team and the deal’s advisers sought out and actively responded to investor feedback on deal structure in a way that was very clearly visible in the programme documentation.

“All sorts of projects or assets could have gone into a transaction of this ilk but that didn’t happen in this case – based on investor feedback,” Ward notes. “Often, the first things investors know about a green-bond programme are what is disclosed in the roadshow. However, the AOFM spent 12-18 months bringing investors along and building its story, and any investors looking at the transaction on launch day shouldn't have had any unexpected surprises.”

Hughes adds that the team was very mindful of the fact that as it is not an early adopter of green bonds among its global peers and therefore made it a priority to “do better” – including on investor interaction. "We placed a real focus on engagement with investors, on being as open as we could and telling our story in the clearest way,” Hughes tells KangaNews. “We were particularly pleased with the work of the structuring advisers and of the collaboration across government.”

Ward also notes the overcollateralisation in the asset pool and says she understands the AOFM has been very conservative on haircutting eligible collateral. She explains: “What the AOFM has done differently from other sovereigns is to include a look-back period of only 12 months rather than the more usual two years. There is also a look-forward period of two years, which is acceptable for a 10-year maturity, and we understand the AOFM has haircut the second year. This means that investors can be comfortable that there is a sufficient asset pool available to support this transaction, any growth in this line and any future new green bonds.”

The AOFM listened to investor preference for allocations to forward-looking expenditure, which Jenkins explains is reflected in the 50 per cent allocation limit within the refinancing look-back period of 12 months prior to the current financial year and the minimum 50 per cent allocation to the current year and two years forward. Jenkins says this is aligned with best-in-class practice from other sovereigns.

“Feedback on this was consistent from investors. It led to the funnel of eligible green programmes and expenditures being narrowed down and ultimately dictated the scale of this first issue,” Jenkins tells KangaNews. The AOFM and Treasury needed to balance the initial deal size with certainty that the pool of endorsed eligible green expenditure programmes would be delivered within the forward-looking, two-year timeframe from the initial issue.”

Hughes tells KangaNews the AOFM shared with investors at the roadshow future plans to tap the new green bond to build volume over time, ahead of introducing a second green point on the curve in around two years.

According to Jenkins, the AOFM will soon be able to look forward with an eligibility window extending to June 2027 and identify the full amount of eligible green expenditures identified for the fiscal year ending in June 2024. “With the passage of time, the AOFM will be able to release and identify further eligible green expenditures, then once endorsed by the inter-departmental Green Bond Committee [GBC] demonstrate that the AOFM can be a frequent green-bond issuer.”

Tapping is likely to be via tender during the next 12 months, Jenkins adds. Once the GBC endorsed eligible green expenditure pool is of sufficient scale, the AOFM will seek to increase the existing line or return for a new, labelled syndicated issue.

“We have a pool of expenditure to support tapping the bond during the next financial year," Hughes confirms. "We will watch secondary market performance and liquidity very carefully.

Given the green label is aligned with Australia’s climate ambitions and requirements, Ward suggests the next opportunity for the government may be to start to show how eligible projects can contribute to the Paris-aligned nationally determined contributions.

She tells KangaNews: “The green label makes sense for now. We can see a role for transition finance eventually and this could be something offshore investors are interested in – particularly because they can see the upside potential for Australia in transitioning. But this is dependent on the performance of transition bonds in other markets.”