Australia's government sector takes the long view

The start of 2019 marks an interesting juncture for Australia’s government-sector borrowers, characterised by falling sovereign issuance, heightened market volatility and the emergence of sustainable debt as a regular funding option. KangaNews gathered the market’s key players at a roundtable discussion in Sydney to exchange views on the outlook.

PARTICIPANTS

Vince Cinquina Head of Financial Markets WESTERN AUSTRALIAN TREASURY CORPORATION
Chris Collard Director, Treasury EXPORT FINANCE AND INSURANCE CORPORATION
Jose Fajardo Head of Funding and Liquidity QUEENSLAND TREASURY CORPORATION
Andrew Kennedy Director, Treasury Services SOUTH AUSTRALIAN GOVERNMENT FINANCING AUTHORITY

Justin Lofting General Manager, Treasury TREASURY CORPORATION OF VICTORIA
Rob Nicholl Chief Executive AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT
Katherine Palmer Senior Manager, Funding and Balance Sheet NEW SOUTH WALES TREASURY CORPORATION
Fiona Trigona Head of Funding and Balance Sheet NEW SOUTH WALES TREASURY CORPORATION

MODERATOR

Laurence Davison Head of Content and Editor KANGANEWS

TURNING POINT 2019

Davison It feels like we might be at a turning point at the start of the new year, both in a macro-market sense and in the Australian high-grade sector. How does the market feel right now relative to historical developments?

COLLARD Generally speaking, markets love to have lots of different moving parts to focus on. There is certainly no shortage of these as we enter 2019. Globally, there is the US economy, growth, government shutdowns and future moves by the US Federal Reserve. Elsewhere, there is slowing Chinese growth, Brexit, trade wars, talk of a recession in Italy – the list goes on.

Closer to home, we have a softening housing market, the ongoing drought, a federal election and monetary policy that is seemingly on hold for another 12 months.

Considering all these factors and others, it would be fair to say this year will be more treacherous for issuers than last. The market feels a tad ‘heavy’ as we start the year. Credit spreads seem to want to eke ever so slightly wider. I think 2019 will be more challenging for issuers than 2018, even in the high-grade space.

LOFTING I think the market is reacting normally to a lot of uncertainty, whether that be the outlook for US short-term rates, US-China trade tensions, Brexit or – domestically – a weaker housing market.

The long end of the US curve tends to peak where the cash rate is going to peak. If the market believes the peak is only a couple of moves away, it’s not an unusual response for yields to start to fall and for the market to start looking forward to the next economic cycle.

It’s also important to note that markets have been thin over the new-year period, so all moves are likely being exaggerated. It’s amazing how quickly US yields went from 3.2 per cent to 2.7 per cent in the pre-Christmas period.

It is probably reasonable to think we are at some sort of turning point, though equally I’m not sure we should expect yields to go significantly lower than they are now. Perhaps ‘decision point’ is a better way of putting it.

FAJARDO For the last couple of years we have been talking about global synchronised growth, and now we are seeing many global economies slowing down – including Japan, Europe and China. The US is the outlier but this has been driven by fiscal policy. At the same time, tighter monetary policy in the US and geopolitical risks, such as trade conflicts and Brexit, have seen volatility increasing significantly.

I suspect it might be a bit early to say definitively that this is a turning point. But equally it feels like uncertainty and volatility are on the rise globally and that this will be a story throughout 2019.

In an environment of elevated semi-government spreads and volatility, I think it’s a positive thing that all the major borrowers in this sector are ahead of their funding run rates for the current year. There is capacity to look for optimal execution windows without being rushed into transactions.

“The market feels a tad ‘heavy’ as we start the year. Credit spreads seem to want to eke ever so slightly wider. I think 2019 will be more challenging for issuers than 2018, even in the high-grade space.”

TRIGONA I agree with this, including the fact that most if not all of us were well ahead of our issuance programmes coming into the new calendar year. We can pick our moment to issue – and this is going to be even more crucial than it was in 2018. As an example, when we issued our green bond last November the timing was conducive to a relatively larger deal than may have been possible two weeks later.

Time will tell whether the market is at a turning point. But we are certainly expecting a lot of volatility through this year and will be mindful of it. Specifically, this means choosing when we issue carefully.

KENNEDY The most consistent thing we’ve seen through the recent part of the cycle has been volatility, and this is the product of global markets adjusting to a decreased pool of liquidity. QE has been taken off the table, central banks are adjusting their balance sheets and interest rates are being raised in some markets – and yet the debt profile is still expanding. This is causing considerable dislocation in long- and short-term funding markets, as well as in credit.

Volatility is elevated because of widespread uncertainty around what happens next. The only thing we can be certain about is there will be continued volatility across all asset classes, driven by the global reduction in liquidity pools and the backdrop of geopolitical risk we have had for a number of years, especially out of the US.

In my view, no-one wins a trade war. All economies end up worse off. This will continue to increase volatility in all financial assets.

Meanwhile, Australia has added macroprudential reform designed to modify lending and investing behaviours. However, it has been implemented so late that it appears regulators now fear they have gone too far too fast and are backing away – despite the fact that the reform is having the intended consequences of slowing credit growth and helping correct the housing market.

NICHOLL Every year starts with a view on how it will be different from the previous one. But we saw a lot of volatility going into the end of 2018 – I was surprised to see the extent of the rally in Australian sovereign bonds building toward the end of last year.

We think there are several influences at play this year. One is something we saw throughout 2018, which is the dynamics of short-term money markets. The behaviour of the repo market has had a definite impact on part of our investor base.

Australia is also experiencing persistently wide negative spreads to the US. At the same time, there is uncertainty about which direction the Reserve Bank of Australia (RBA) will go next. The cash rate has been steady while there have been definitive moves elsewhere in the world.

A factor we don’t often talk about – but is relevant given market activity – is what’s happening in equity markets. Global allocations between equity and fixed income matter a lot, and they will be heavily influenced by perceptions around whether there is much more profit to be had from the commercial sector in this cycle.

Finding the next new dollar

Issuers were pleasantly surprised by the strength of demand from Australian real-money accounts in 2018. Incremental bid growth for state-government bonds in the coming months could rest on converting more accounts from the sovereign sector.

DAVISON Where do high-grade issuers think the marginal investor might come from over the next 12 months?

CINQUINA There are still investors out there that are yet to participate in the semi-government sector, including in Europe and Japan. We just need to continue to undertake marketing. Whether there are new names out there we haven’t heard of comes down to the information we get from our panel banks. We won’t find them on our own.

NICHOLL For the states, the next investor is most likely to be one that has already been participating in the government bond market. A European central bank I spoke with late last year – an account that has been in the government bond market for a couple of years – had a lot of questions about the semi-government sector. It seemed to be gearing to move in this direction, which is a pattern we have seen in the past.

The combination of marketing and the establishment of the AOFM’s 30-year bond has made a huge difference in our market. Our ability to issue longer than 10 years has been greatly enhanced.

FIONA TRIGONA NEW SOUTH WALES TREASURY CORPORATION

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Davison Is there any intelligence coming through so far in 2019 that gives an indication of how the new year will shape up? For instance, is there any sense that the rally in bond yields is executable given the thin nature of trading in the new-year market?

NICHOLL It’s always hard to tell. We had a buyback and matching tender in mid-January and while the coverage was alright the pricing didn’t look particularly strong. There is certainly a lot of volatility out there and it’s hard to pin down exactly what is causing it.

CINQUINA Markets would have felt until recently that they had a fairly good handle on how 2019 might look in Australia. There was a decent consensus that the next RBA move would be up – though we didn’t see it that way, and still don’t. We have seen a bit of movement in recent weeks that suggests market participants are starting to think cash rates will be unchanged at best and lower at worst.

My suspicion is that the market remains unsure. We’ve seen a bond rally and market conversations are clearly contemplating the possibility of rate cuts. At the same time the US is slowing and the fiscal stimulus it has had from tax cuts will wear off at some point in 2019. On this basis, maybe we have seen the cash-rate peak.

The point made earlier about volatility is the key one to keep in mind – it’s not going to go away and if anything it will get worse. It probably won’t subside until we get more certainty about cash-rate direction. Our view is that the RBA will be on hold at least through 2019.

TRIGONA We have the same view. We’re keeping a close eye on macroprudential policy and its impact on the housing market. But it’s very hard to predict a rate cut, because the RBA will be very reluctant to do it.

FAJARDO The market has gone from pricing in hiking, in November 2018, to predicting rate cuts, in January 2019. Our view is that the two biggest domestic risks are the consumer and housing sectors while globally our biggest trading partner, China, is slowing. Even so, we still think the RBA will likely be on hold at least for as long as inflation is muted and employment growth remains reasonable.

NICHOLL What I hear from investors suggests it would certainly be a big call for the RBA to cut, particularly when growth is around 3 per cent and the possibility of another external shock in the next 18-24 months sits over us. I think the RBA will remain cautious.

LOFTING It is scary to think we might be starting an easing cycle at 1.5 per cent. A couple of moves would signal a very negative backdrop, so I think the cash rate will remain on hold. One would have to think the hurdle for the RBA to cut is very high.

CINQUINA I think the RBA would want to see the result of the federal election and what the new policies around housing and tax are. This is a real risk: there is a lot of exposure to this part of the market for households and if the election goes the way the polls are suggesting and the policies being proposed are implemented there are obvious implications.

I imagine the RBA would want to hold on to its bullets in case there is a need to act.

Davison Is the market globally confronting what ‘lower for longer’ means and what an economic cycle without inflation, wages and credit growth looks like?

NICHOLL I don’t know how anyone could have the view that global conditions will return to what they were pre-2007. Worldwide, there is a lot more debt. The share of income for labour remains relatively low and without a structural uplift in productivity growth I don’t see the underlying dynamics for global demand and growth changing that much.

TRIGONA It is the new normal.

COLLARD I agree. The economic and interest-rate cycles are now very different from what they were 10-20 years ago. The textbooks are being rewritten.

NICHOLL Obviously, we will perceive rate shifts relative to different points within a range. But I see the range as being lower overall and possibly tighter than it was previously.

“I suspect it might be a bit early to say definitively that this is a turning point, but equally it feels like uncertainty and volatility are on the rise globally and that this will be a story throughout 2019.”

Davison To put today’s market in context, if 2017 offered close to perfect funding conditions for borrowers how far are we from that period of ultra-benign liquidity and pricing at the start of 2019?

KENNEDY All issuers’ chief strategic objectives should be access to markets, which means they need to be aware of all the factors that might prevent access. For Australian semi-government issuers, this conversation has always centred on investor diversification. The challenge is that diversification is not always entirely in issuers’ own hands.

While Australia’s currency should help attract investment, we also have a negative interest-rate environment relative to the US Treasury curve. This means we’re not getting the interest we were when the Australian curve was trading above the US. This has been the biggest game changer in preventing high-grade issuers from diversifying their investor bases.

LOFTING I agree that it is a lot more difficult than it was a couple of years ago. The first part of 2018 was good, with regular demand in our space from Japanese investors which underpinned what a lot of issuers in our sector were doing, particularly at the long end of the curve.

We did two transactions in the second half of 2018 – a 2021 issue and a 2028 syndication – and these both went well. But it certainly would have been harder to issue in December when the market closed up a bit and volatility stepped up. Markets were thin and it looked very difficult.

Coming into 2019, we did a tender in early-to-mid January which I’ll admit was a brave transaction given the currency volatility the week prior and the fact that we didn’t have a lot of information around the support we would get from investors. Nonetheless, a core funding need we hadn’t expected appeared, so we moved ahead.

In the end, the tender went better than expected from an issuer perspective. However, spreads widened by a couple of basis points in the following week, reflecting expectations of further semi-government issuance. Recently we have seen bids come in and pricing moving back, so whether this volatility is just a thin January market or the shape of things to come is unclear.

It does feel that this year will be more difficult and we will have to bear this in mind when we consider our funding plans. There is ongoing transition in the high-grade sector as the Australian Office of Financial Management (AOFM) is reducing issuance while the broader semi-government sector is increasing debt going forward.

NICHOLL This underlying dynamic has to be putting pressure on spreads for semi-government paper.

TRIGONA Early January 2019 is quite a contrast to the start of 2018, when Queensland Treasury Corporation (QTC) was able to get out early in the new year with a large primary-market deal. Conditions definitely feel different.

LOFTING Speaking today, in mid-January, the issuance and pricing numbers might not be much different from last year or the year before but the market tone definitely seems muted. It may be like that through this year.

Last year there were times when multiple semi-government issuers were able to access the market all in the same week without causing a problem. With the caveat that outlooks often tend to be more negative than what eventuates, I do think there will be pockets of time this year when it will be difficult for this kind of supply to take place.

NICHOLL The feedback we consistently receive is that liquidity in Australian Commonwealth government securities remains very strong. This is not always the case in the linker market, but it varies across time and by investor.

One thing we have noticed over the course of the current fiscal year is that there is a greater concentration of interest in futures-basket bonds than there has been in previous years. This is evident from our issuance activity. It isn’t just a lower requirement that is causing our issuance focus – we are also seeing less inter-basket bond demand.

“If we go out with a social bond under the TCorp framework we need to make sure our assessment of a social asset meets broad expectations of potential investors. The SDGs are probably the best way to do this.”

INVESTOR SUPPORT

Davison As market liquidity starts to change, do issuers have the sense that investors are focusing particularly closely on relative value?

FAJARDO Investors have always had a focus on the relative value of semi-government bonds to alternate assets – be it to bond, global supranational, sovereign and agency or swap.

This was highlighted in our new 2029 benchmark bond issue last year. Real-money accounts perceived this part of the curve to offer good relative value so we saw very large participation from these investors. In other deals, bank balance sheets have been the biggest participants as the trades offer good relative value on a swap basis.

This said, relative value is not the only driver of demand as investors, for example, may need to buy particular bonds for index- or liability-management purposes.

CINQUINA Our sense is that bank investors have become more nuanced. They are still participating but I agree that it more often comes down to relative value. If a deal is at the right level they will be there.

The positive development on the demand side has been that asset managers have stepped up. This sector has been a strong source of support through 2018 and I’m hoping it will be the same in 2019.

On liquidity in general, there is still plenty of cash out there and a lot of maturities coming up so there are opportunities to issue. It is all about timing. You need to time when the price is there for the investor base you are targeting.

The days of balance sheets being the primary supporters of transactions are over, but no-one expected this would last forever. Last year proved this point.

LOFTING The biggest balance sheets all operate differently now, too, and we don’t see them all coming into the same transactions. We may see one or two but we don’t tend to see them all, because they have different positions and views on relative value.

KENNEDY In my view forthcoming regulatory changes, such as APS 221, will cause bank spreads in the senior space to widen further. The unintended consequence of trying to improve banks’ regulatory capital and reduce their interdependence will in my opinion be the big hurdle to the continuation of the negotiable certificate of deposit (NCD) market.

If this happens it will be very difficult to price bank bills – one-month NCD issuance is already limited and these regulatory changes may put pressure on three- or six-month issuance and the senior-unsecured market. This would in turn drive the domestic banks to borrow offshore.

At the margin, this should improve the landscape for semi-government issuers because bank balance sheets will continue to need to hold paper for high-quality liquid-asset purposes. There are a number of different compensating factors and ultimately market pricing is the intelligence of each participant in the market at that point in time. Bonds will find their level, which is really what relative value represents.

FAJARDO These comments all come through in distribution data. The 2029 trade we completed in October last year was the largest fixed-rate semi-government deal in our market since 2011. The older deal was also a QTC trade, so I compared the books and found them to be quite different. The 2011 deal didn’t have as diversified an investor base as we get now.

TRIGONA That’s an interesting point. This time last year we would have been talking about what would be the next investor base for our bonds – and it has turned out to be Australian fund managers.

LOFTING The 2021 deal we did last October had no bank treasury participation at all.

COLLARD We have a similar story. Our only foray into the domestic term-debt market in 2018 was a long 10-year, fixed-rate bond. This was distributed entirely to real-money accounts – in our experience domestic real-money investors have been super supportive.

Davison Why has domestic real-money investor demand been so strong?

KENNEDY My sense is that it is because superannuation pools are continuing to grow and asset managers are broadening their mandates to hold a greater proportion of fixed income in their portfolios, versus their traditional overweight exposure to equities.

While this has been a win for the sector it has been balanced by the fact that, at the same time, it has lost some appeal to offshore investors on yield basis. We have also seen a slowdown in credit growth from the banks that has eased demand from that quarter.

PALMER Another part of it is probably that there has been a widening to government spreads. The last big transaction we did – which may be a little different because it was a green bond – was allocated 70 per cent to asset managers.

You can’t necessarily compare the bond we did a year before like-for-like, but that particular deal had 50 per cent allocation to asset managers.

FAJARDO The relative value of semi-governments to sovereign bonds is the highest it has been for a few years. The extra 55-60 basis points over government bonds in the 10-year part of the curve is certainly appealing to investors.

Davison Has the AOFM seen a corresponding decrease in domestic real-money participation based on the same relative-value equation?

NICHOLL Not noticeably. We saw bank balance sheets buying a lot more of our paper up to mid-2018 but this seems to have abated. We don’t expect a repeat of this going forward, because – as has been noted – their asset-accumulation is all but complete. Fund managers have been fairly consistent. They tend to stand out more in the linker market and the new 2050 inflation-linked bond had a large asset-manager allocation.

Davison Does this suggest it has been the marginal domestic investor dollar that has been going to the semi-government sector – in other words that the states have benefited from funds inflows rather than reallocation of funds?

TRIGONA We saw the same names involved but with far larger tickets. They were much more committed than they were a year ago.

CINQUINA I wonder whether the reduction in bank balance-sheet participation makes asset managers look comparatively more active. Although this is probably not the case in the New South Wales Treasury Corporation (TCorp) green bond, given its size.

TRIGONA We printed A$1.8 billion (US$1.3 billion) and real-money support was certainly very evident.

CINQUINA We only did one syndicated transaction in 2018, of which 50 per cent went to real money and 17 per cent to bank balance sheets. A further 38 per cent was placed offshore, which was a good result in the circumstances. As I say, my suspicion is that perhaps higher asset-manager participation was a reflection of the waning interest of bank balance sheets.

FAJARDO We had 70 per cent real money in our 2029 deal. The majority was domestic and it really helped drive the book. Another change we noticed was that these investors came in early and strongly.

TRIGONA We noticed this too. Getting early momentum is very important.

“The positive development on the demand side has been that asset managers have stepped up. This sector has been a strong source of support through 2018 and I’m hoping it will be the same in 2019.”

JAPANESE DEMAND

Davison The bid out of Japan was very supportive for a period but now it seems to have waned somewhat. What are you seeing as the drivers for Japanese investors at the moment?

TRIGONA Demand from Japanese investors was very strong in the first quarter of 2018 but it waned as the year went on.

COLLARD The Japanese market has been an important part of Export Finance and Insurance Corporation (Efic)’s funding strategy in various forms over the past 25 years.

Although we haven’t issued into this investor base of late, our name remains well recognised across the product range and we quite regularly receive reverse enquiries particularly for longer-dated issuance. But I guess this is not surprising given our niche status in the market, and it may not be reflective of demand more generally.

KENNEDY New flows into Japanese funds have all but dried up, especially from the traditional retail funds. There is still money invested but not pools of new money. Our data analysis indicates that during 2014-16 Japanese investors held 10-15 per cent of semi-government issuers’ total outstandings. Now that proportion is closer to 5-7 per cent. Japanese investors have halved their exposure to Australia over the last 2-3 years, in other words.

On the other hand, almost every Japanese investor I met during our January 2019 roadshow said they would like to buy our bonds – it’s just that it’s hard to justify at 50 basis points through the US curve. This feedback is typical across all offshore investor bases in which issuers have been seeking to diversify.

FAJARDO Japanese demand seems to be a bit skewed to the currency view at the moment rather than on a hedged basis, given it’s not as attractive as we have seen previously. We hear there is less Australian dollar product being sold thanks to higher allocations to US dollars that are being driven by the negative spread. It’s important to note, though, that we are not seeing any large selling as a result of this.

TRIGONA We were aware of some selling that occurred towards the end of last year when Australian dollar-yen hit ¥83 (US$0.74). But now it is around ¥77-78 and we expect to see some demand coming back.

FAJARDO We are also seeing some significant investors move to the double-A space from triple-A, looking for higher yield and more liquidity. While this has not been fully represented in syndicated, primary-market participation, we have had some instances of large reverse-enquiry tickets from these investors.

NICHOLL We have to be pragmatic about the outlook for Japanese investors, though. The reality is that November 2018 was the largest month for selling in our market by Japanese investors since 2013.

The biggest selling by outright volume was sovereign paper but they were also net sellers of nongovernment fixed income and Australian equities. The data show that Japanese investors were selling out of all bond markets and allocating into the US, where they had previously been selling for a while.

I suspect they see the prospect for further strength in the US dollar. The US dollar remains their preferred currency with euros second. The Australian dollar has slid back to some extent and it will be interesting to see whether this is the beginning of a pattern or just a short-term phenomenon.

Davison This can’t be entirely surprising, though – we talked about it as a prospect last year as the rates differential went negative.

NICHOLL Yes, and it is true for most sovereign bond markets. But we certainly felt it, and the data confirm it has been happening across our market.

FAJARDO It is more challenging on a relative-value basis when you look at these factors. But the feedback we get from investors is that they are still very comfortable with the Australian economic story.

NICHOLL How comfortable they are with the outlook for the currency is another important point. I think there is an increasing tendency for Japanese investors to do unhedged investing, and their view on the currency will strongly drive this activity.

SUSTAINABLE FINANCE

Davison Treasury Corporation of Victoria (TCV) opened the green-bond market for Australian semi-government issuers, QTC increased deal volume with its debut and – last year – TCorp took the sector to a new level of volume. How has green-bond strategy and capacity developed since the first issuers debuted?

LOFTING We had a pool of around A$2 billion (US$1.5 billion) of suitable assets when we issued our green bond in 2016 but we didn’t need A$2 billion of funding.

The reason we haven’t been back to the market is the same: we haven’t needed a significant amount of funding in the past few years. Since TCV’s green-bond deal, the Victorian government has privatised the Port of Melbourne for A$9.7 billion and sold Snowy Hydro for A$2 billion, so we haven’t needed to go to the market. There is capacity to issue more under the green-bond programme, though.

At the same time, our transaction was the first from our sector and there was limited demand at the time. The TCorp deal reflects how much this has developed over time. I suspect TCorp benefited from marketing a green bond but also recognising that it is a funding source in and of itself.

What I’m saying is that even though ‘dark-green’ investment is still limited, other investors could still participate because the TCorp transaction was big enough to create a liquidity point for them. Our green bond was a bespoke deal of interest primarily to specialist green investors.

We didn’t need more money at the time but the reality is I don’t think the demand was there for a A$1 billion deal in 2016 even if we had. QTC and TCorp’s deals show that demand has built. I don’t think the market is growing exponentially but everyone is interested now.

PALMER TCV was the first in the market and it was a very good transaction at the time. The Australian green-bond space was much smaller then.

LOFTING Exactly. We did A$300 million and that was taking every dollar available from every green-bond investor in Australia. We had a couple of London-based funds as well, but there wasn’t any ‘green money’ left on the table.

FAJARDO When we issued our green bond we only had an asset pool of A$1 billion so there was a constraint on the volume we could issue. This has now grown to more than A$4 billion – so there is certainly capacity.

Our pool is primarily low-carbon transport assets. While we don’t have imminent infrastructure requirements like the other states, we can certainly grow the portfolio as a lender to state water entities and other areas. Our first real infrastructure requirement in the future is CrossRiver Rail in Brisbane, which is in 2021. This is low carbon and could certainly be included in the asset portfolio.

Davison Do the states expect their thinking about green bonds will focus on the additive quality they offer on the investor side? In other words, that any investor should be able to buy but the specialist funds will provide incremental demand.

LOFTING Yes, this is an additional benefit. Investor interest and understanding on what is in the pool and the kinds of assets they like and dislike has changed dramatically from when we did our transaction.

The information requirements and demands of green-bond investors are much higher. It isn’t just about them ticking a box: they are interested in where the money is invested and what the carbon-emissions outcomes are.

NICHOLL The trade-off for the growing pool of funds available will be that the bar for investor expectations gets higher. The AOFM has no current plan to issue green bonds but it is increasingly clear to me that European fund managers in particular have growing mandates for environmental, social and governance (ESG) investments. My guess is that at some point in the future all sovereigns will have to look at meeting these mandates in some way or another.

LOFTING The challenge is finding assets that meet investor requirements and recognising that what the requirements are now will likely change over time.

The green-bond structure is designed so that you can pull assets in and out of the pool if required. But from an issuer’s perspective understanding the assets in the pool and how we collect and provide information to investors will need to continue to improve as demand increases. Choosing the pool is very important.

PALMER Absolutely. The transparency was always there but the requirement for specifics around impact investing is increasing. During our green-bond roadshow there were very specific questions about assets that we hadn’t expected. We are certified under the green-bond standards so there is a roadmap, but the questions went beyond this.

For instance, there were questions about the Sydney Metro North West – the primary asset – which were concerned with the preservation of aboriginal artefacts. There were questions about social implications even though it was a green bond.

Shifting sands for sector issuance

One of the major dynamics on the issuance side for Australian government-sector issuers is the projected net new-issuance decline for the Australian sovereign. This will influence future funding strategy for the sovereign and states.

DAVISON The outlook for Australian Office of Financial Management (AOFM) funding has changed. Why is this, and how does it affect the AOFM’s investor relations approach?

NICHOLL The driver is the strength of Australia’s fiscal position. Our net issuance has fallen significantly. The question is whether this is cyclical or structural. I think it is fair to say in the last 12-18 months most of the strength in the budget position has been driven by revenue.

We continue to see high tax collection, particularly from the corporate sector. Unemployment is also low so income-tax collection is generally elevated. I don’t see this changing quickly – and this is a view I think is shared by investors.

We don’t feel there is as much need to be face-to-face with investors as we have been, but this is no reason to ‘abandon the field’. We are thinking about how we can continue to provide updates, meaningfully.

ROB NICHOLL AUSTRALIAN OFFICE OF FINANCIAL MANAGEMENT

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Davison Is demand for green bonds expanding beyond domestic investors and the acknowledged market leader, Europe?

FAJARDO The experience we have had on our recent roadshows suggests the green theme is an area of increasing interest for Japanese investors, too. But, as with any other deal, demand conditions need to align with when we want to execute.

TRIGONA Our experience is that Japanese investors don’t always participate in primary as they don’t always have the funds to invest on the day. When the Japanese investors have funds to invest they tend to tap our bonds and we will issue into this specific bid.

Our strategy with respect to taps is to issue into demand. We are able to achieve this as we warehouse risk on our own balance sheet rather than issuing into the market when investors are not buying.

DAVISON Looking forward, could green bonds become a liquid curve alongside mainstream programmes?

FAJARDO There are scale limitations because of the pool of assets required. On the demand side, I don’t believe dark-green demand really grew between our trade and TCorp’s. It is growing in Europe but I think we would only really access this with a euro-denominated deal.

NICHOLL I think demand will reach a saturation point more quickly than assets can be developed to meet the requirement.

FAJARDO QTC has benefited from having large, liquid benchmark lines. The constant message from investors has been that they like this depth, and we see green bonds as a complement to this. We have become a programmatic issuer of Climate Bonds Initiative-certified green bonds, which streamlines the process for future issuance.

“The green-bond structure is designed so that you can pull assets in and out of the pool if required. But from an issuer’s perspective understanding the assets in the pool and how we collect and provide information to investors will need to continue to improve as demand increases.”

Davison To what extent does the growth of dark-green funds really matter given the fungibility of green and mainstream bonds?

FAJARDO Developing the market is also about moving investors from light to dark green or from nongreen to green. You have to approach the market with this in mind rather than only looking for dark-green investors.

TRIGONA There are reporting costs to consider, too. It is not as easy as issuing a benchmark bond where there is no ongoing reporting requirement once it is completed.

LOFTING The investor diversification is important, though. I imagine TCorp’s experience was similar to ours in that the level of engagement with investors is much greater on a green deal.

PALMER Similar to QTC, the focus for TCorp is still on highly liquid benchmark lines. But I also agree with Justin Lofting that the diversification angle is important. Even if the dark-green investor set remains small the ability to tap into this sector is one of the advantages of green-bond issuance.

TRIGONA These investors are also more likely to be sticky. If they are going to sell, it is unlikely that the green bonds will be the first bond they sell.

Davison Is this where the pricing element comes in? We have heard, especially in Europe, that there is some differential pricing for green bonds in the secondary market.

LOFTING For us it was not just about price. One of the benefits of the green-bond process was that it allowed an alignment of Victoria’s values as a government and its investments in addressing climate change with investors globally that want to invest more in this space. This alignment across TCV, our clients and our investors allowed us to engage more deeply with our stakeholders. This doesn’t necessarily mean our funding levels will be better than they were, but the level of engagement is better and there is more investor diversity.

Davison What is the extent of TCorp’s ambitions and capacity for social bonds?

PALMER Our programme was set up as a sustainability programme so we can do green, social or a combination thereof. We are looking to map to the UN Sustainable Development Goals (SDGs), which is what a lot of investors are also mapping to.

New South Wales (NSW) state-government spend on infrastructure is roughly A$90 billion over the forward estimates with A$7 billion each on education and health. As part of the usual remit for a semi-government spending is occurring on assets and projects that have a social outcome there is potential for inclusion of these assets in a social or sustainability bond.

The challenge is that the social-bond space doesn’t have as much evolution on recognised standards. The green-bond standards are much more developed. If we go out with a social bond under the TCorp framework we need to make sure our assessment of a social asset meets the broad expectations of potential investors. The SDGs are probably the best way to do this.

NSW also focuses on growing social-impact investment through the Office of Social Impact Investment (OSII), which is a joint venture between NSW Treasury and the Department of Premier and Cabinet. OSII delivers investments for social impact and focuses on payment-by-outcomes contracts such as social-benefit bonds.

“Almost every Japanese investor I met during our January 2019 roadshow said they would like to buy our bonds – it’s just that it’s hard to justify at 50 basis points through the US curve.”

Davison Efic, Western Australian Treasury Corporation and South Australian Government Financing Authority (SAFA) are yet to be involved in green bonds. Does an outcome such as that achieved by TCorp, in volume and breadth of book, push the concept up the agenda?

CINQUINA It was certainly an impressive trade and I was also impressed to hear that TCorp found 15 new investors. We are looking at the sector but we don’t actively have projects in train that would result in issuance in the near future.

Western Australia doesn’t undertake a lot of funding without a social or environmental factor. The state government also announced late in 2018 that it would review its environmental policy. We are looking at the space and we are speaking to clients about activity in the sector, but at this point there is no project for delivery of an outcome.

COLLARD Efic continues to monitor the green space but, to date, we haven’t had sufficient suitable assets to warrant this type of funding. However, Efic does engage in responsible lending and upholds social and environmental best practice in the transactions it supports.

KENNEDY Any government – federal or state – is mandated by the people to be fiscally, socially and environmentally responsible in everything it does.

As a state, South Australia has assets of A$80 billion focused on delivering on this mandate and total debt outstanding of A$20 billion. One of SAFA’s biggest challenges is lack of liquidity in benchmark lines and we would not want to detract from the pool of liquidity in order to satisfy a small, single bond issue.

SAFA’s long-term strategy when it comes to ESG factors and bond issuance has been to seek to have its entire programme certified rather than to focus on one particular bond issue. This continues to be SAFA’s message and key strategy, and one we aim to deliver.