Chapman Tripp's Luke Ford.
COMMENT:
New Zealand's sustainable debt markets have taken time to establish but are now showing signs of momentum, familiarity with the product, and innovation. This comes as demand for sustainable finance options is picking up globally on the back of flexible product offers which respond to current crises.
New Zealand would do well to keep up with the pace.
More progress under the hood
The market for sustainable bonds (also known as green, social and sustainability bonds, or GSS) has not broadened over the past 12 months to the extent we expected it might. No new large issuers have emerged since Westpac's offshore green bond just over a year ago, regulators have continued to emphasise caution in relation to both the marketing of, and investment in, such products, and businesses have focused on more immediate concerns.
But look under the hood, and there has still been significant progress.
Almost from the outset, the New Zealand market provided an impressive range of sustainable finance issuers across both public and private sectors. This includes Crown agency Kāinga Ora, local government (Auckland Council) and corporates (Contact, Argosy), with Westpac adding the bank sector and the International Finance Corporation's green Kauri bond in the supranational category.
Concerns about a lack of depth and familiarity in the market remain but they are being chipped away through volume and repeat issuances, paving the way for new entrants.
Auckland Council and Argosy have issued successful follow-ups to their debut green bond issuances from previous years, and Contact's entire borrowing programme remains green-certified.
Since expanding its sustainability financing framework in September last year, Kāinga Ora has issued $2.3b of wellbeing bonds (a green and social bond aligned to the Treasury's Living Standards Framework) to wholesale investors. This included New Zealand's first inflation-indexed sustainable bond, announced during lockdown. The wellbeing bond has a 20-year maturity and provides returns that increase with inflation, delivering very long-term financing to match Kāinga Ora's housing portfolio and revenues. It is representative of the long-term commitment to sustainability and wellbeing by both investors and issuers in this space.
Social bonds pick up pace
The global pandemic and the recent civil unrest have underlined the need for governments and corporates to reset their priorities and place a higher importance on people and community concerns. This has truly established social bonds internationally, setting them alongside the now almost traditional green bond.
According to Moody's, while worldwide sustainable bond issuance fell to US$59.3b in the first quarter of 2020, caught by general economic fallout, social bond issuance was up to US$11.9b – more than double the previous quarterly record.
This expansion also comes at a time of increased investor engagement, with activist equity investors forcing a focus on ESG (environmental, social and governance) reporting. A new class-action lawsuit on climate change disclosure for Australian government bonds brings that approach to debt investments, but sustainable bonds otherwise fill this gap, providing debt investors with opportunities to engage on the issuer's business direction and the results of their investment.
The number of 'sustainable-focused' funds and investors continues to multiply. And while it remains generally true that sustainable bonds are no cheaper to issue than standard bonds, sustainable debt investors can be attractive to issuers because of their long-term horizons and the diversity they provide – both of which can help increase funding certainty in difficult times.
A time for innovation
By February 2020, the first Covid-19 response bonds had been launched internationally, with issuances totalling billions of dollars since then. These bonds often take established social bond principles and target them at pandemic-related issues. Their quick creation shows increasing familiarity with sustainable funding as a powerful tool.
Innovation is also helping to address an abiding concern with traditional "use of proceeds" sustainable bonds; that a failure to deliver positive social or environmental outcomes does not have consequences for the bond issuer. Last year Italian energy company ENEL issued the first sustainability-linked bond, where the interest rate was calibrated to the issuer's overall performance against ESG development goals.
In that case failing to meet a pre-agreed target will result in an interest rate hike, incentivising the issuer to improve its ESG performance over time. These bonds are modelled on sustainability-linked bank loans, which have already proved popular in New Zealand with borrowers such as Synlait and Contact. Formal market standards for the bonds have since been developed to encourage uptake.
At the community scale in New Zealand, we have seen a growth in tailored products which allow local groups to fund social purposes with investment provided by those in the area who share their interests. These can be customised to strike a balance between social outcomes and financial return.
In recent months, we have seen a range of products from secured limited recourse project finance for social housing developments to a potential small offer of unsecured bonds to support donations to a social charity. While these products are often limited by a small investor base, they can contribute substantially to their local communities.
New Zealand and the world
New Zealand did not take up sustainable debt funding until 2017, almost a decade late in the global context, and is still trailing behind the accelerating international markets in terms of both growth and innovation. However, the groundwork has been laid..
Our lack of a large institutional investor base means our market is often dominated by retail investors. This probably slowed uptake in the past, because investors must first be comfortable with what sustainable bonds are, and how they compare against each other. But retail participation helps drive change. Retail investors are not required to adhere to a specific mandate, and can look to make a difference with their money as well as obtain a financial return.
Along with law reforms such as the recent Zero Carbon Act and impending climate-related risk disclosure, the Government's second Wellbeing Budget shows a desire for the country to address long term social issues and intergenerational wellbeing, with substantial allocations aimed at the health sector, education, employment, housing and family violence services. Although the ramped up Government bond programme (including an additional $50b of borrowing expected in the first year) does not earmark specific proceeds for sustainable projects, transparency and clear direction helps reinforce a national sustainability focus.
Private and government-led projects such as Capital Markets 2029, the Sustainable Finance Forum and the Living Standards Framework are encouraging innovation, and we are seeing new platform development. NZX's green bond designations and wholesale debt market can provide a potential disclosure hub for larger issuers, and alternative markets (such as the expected establishment of Catalist) may provide a similar home for smaller sustainable bond offers.
So while NZ was slow to take the field and has often watched from the sideline, we are now in position to make a far bigger impact.
- Luke Ford is a Senior Associate at Chapman Tripp.
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