For many corporations, green and sustainable financing has become a significant area of focus in the past couple of years.
As Tom Bolton, head of corporate finance at Thames Water, points out: “It’s something that’s been around for a long time, but in what feels like a relatively short space of time, it appears to have become mainstream.”
This topic will only become more important in the future.
Before the coronavirus crisis escalated, industry commentators had pinpointed sustainability as one of the top considerations for treasurers this year.
While the current situation may hinder planned activity for some, sustainability continues to be an important topic for companies around the world.
For treasurers, navigating the green and sustainable finance market is something of a challenge – not least because some areas of the market are at an earlier stage of development than others.
At the same time, there’s a certain degree of overlap and confusion when it comes to the terminology used to describe the different routes available.
What’s in a name?
Where language is concerned, terms like ‘green finance’, ‘sustainable finance’ and ‘transition finance’ are sometimes used interchangeably, but each has a distinct meaning.
• Green finance. Kwok Liu, deputy treasurer, funding & investment at National Grid’s group treasury, explains: “We see green financing as a type of financing where proceeds are used to specifically fund certain projects with environmental benefits. The market standard in Europe is for this type of issuance to be aligned with the International Capital Market Association’s [ICMA’s] Green Bond Principles.”
• Sustainable finance. Sustainable financing, Liu says, involves linking the coupon paid to a sustainability metric or goal, and aims to promote wider sustainability criteria or commitment to the UN’s Sustainable Development Goals – “but it’s a product that is perhaps not as well developed as green financing”.
• Transition finance. As well as green and sustainable financing, another emerging area is that of transition financing. The focus of this is on sectors that are currently ‘brown’, but are working to transition to green. In March, UK gas distribution network Cadent announced that it had issued the UK’s first transition bond in the form of a 12-year €500m issuance. The proceeds will be used to reduce greenhouse gas emissions.
• Impact investing. While not a form of financing, impact investing is another term that is gaining traction in the sustainability conversation. “It’s about the philosophy of investors when they make a decision on where to allocate their capital,” explains Liu, “which includes both financial considerations and the positive impact that can be achieved in terms of social benefits and benefits to the planet.”
While ESG factors may be top of mind for many companies, when it comes to debt issuance it’s clear that different parts of the market are at different levels of maturity.
At this stage, green bond issuance is seen as a well-trodden path for companies – not least because of the structure brought by the ICMA’s Green Bond Principles, which are intended to provide guidance for issuers, investors and underwriters. As Lisa Dukes, deputy group treasurer of power company Drax, says: “If you’re launching a green bond, you know what’s expected of you.”
Sustainable finance and transition finance, in contrast, are at an earlier stage of development, and as Dukes remarks, “there is definitely a lack of structure around those markets.”
Likewise, green and sustainable financing is more developed in some regions than in others, with Europe appearing to be particularly advanced. Thames Water was the first UK corporate to issue a green US private placement, with a £705.1m issuance in March 2018.
“At the time, investors had relatively limited knowledge of concepts such as the green bond principles,” says Bolton.
“There has definitely been a noticeable change in the past six to 12 months – but not to the extent that investors are bringing multiple ESG analysts along to meetings.”
Demand and drivers
Demand is being driven by a number of different factors, including investors as well as the board, the workforce and the company’s customer base.
“We see a lot of demand for green bond issues, especially from debt investors in Europe,” says Liu. “We see them becoming more focused on ESG, and we know it’s becoming an increasingly important part of their investment process.”
He adds that certain investors have dedicated green bond portfolios, and investors are particularly keen to invest in green assets. “And on the equity side, I know the equity investor relations team gets a lot of questions around ESG as well.”
“Investors are showing a lot more interest in green issues, with many keen to make greener investment choices,” adds Jay Joshi, treasurer of property investment and development business Derwent London. “I can’t remember the last time I went to an investor meeting where climate change and ESG weren’t on the agenda.”
But demand isn’t just coming from investors.
As Liu explains: “The board cares; our equity investors care; and our stakeholders care. National Grid plays a very important part in the UK’s transition to net zero, so demonstrating our commitment to that is really important.”
Customers are increasingly driving demand for evidence of organisations’ green credentials
Another consideration is the role that green and sustainable financing can play in improving a company’s reputation, and thereby increasing its appeal as a place of work – for both current and prospective employees.
Bolton says, “Staff are interested. We have got a big commitment to what we call public value – it’s one of our strategic goals. And staff certainly buy into that.”
Likewise, he says that prospective employees are taking a keen interest in the organisation’s environmental credentials: “We are attracting a lot of highly motivated graduates, and they are asking questions.”
More broadly, customers are increasingly driving demand for evidence of organisations’ green credentials. “We have a customer arm that supplies electricity to B2B,” says Dukes.
“We are the largest provider of renewable energy, and there’s a massive demand for that type of energy. People want green energy – they want to be able to say in their annual report and to all their stakeholders that all their energy is green.”
She also points out that individuals are mandating investment managers to take on more green and ESG investments within their portfolios.
Green and sustainable financing in action
Different companies will approach this area in different ways, whether their focus is on green revolving credit facilities (RCFs) or sustainable bonds.
Drax, for example, was the first global generator to issue an ESG-linked term loan. “The margin was adjusted based on carbon intensity achieving a benchmark,” says Dukes.
She adds that while the company has also been reviewing green loans and green bonds for some time, “given that we already had a strong ESG slant to both our core and working capital finance, we didn’t see green bonds as a compelling addition at this stage.”
Joshi, meanwhile, says, “the property and construction sector has a large carbon footprint, so we have a responsibility to do what we can to reduce that.”
In the case of Derwent London, this has included putting in place a five-year, £450m RCF, which includes a £300m ‘green’ tranche – the first such facility to be agreed within the UK’s real estate sector.
“Lenders have a green agenda, too, and want to issue green products,” Joshi comments. “You’re effectively pushing on open doors. If you go to your bank and want to talk about green financing, it’s probably already on their agenda.”
In January of this year, National Grid issued a €500m green bond, with the proceeds set to finance electricity transmission projects with environmental benefits. “We went for green because it’s the most developed market,” Liu says, although he adds that the organisation is monitoring the market to see how different areas develop.
“We could certainly look at transition financing, and in the future we could look at sustainable financing,” he says. “But we’re waiting to see how the market develops, because those two forms of financing are currently somewhat behind green financing.”
Down to the details
For companies looking at green and sustainable financing, the cost of going down this route will be a major consideration. While companies may save a couple of basis points on margins, this may be erased by the cost of carrying out necessary verifications.
Nevertheless, as Joshi points out, “It’s not actually about reducing margins on the debt facilities or savings on the associated costs.”
He argues that the more significant benefits lie in strengthening the company’s relationships with stakeholders, from employees to policymakers and investors. “When you embed a green agenda throughout the whole business, you’ve then got to look at the cost or the benefit across the whole business, too, because the benefits will really come further down the line – and not specifically on the cost of the debt,” he says.
Alongside costs, treasurers will also have questions about the practicalities. Liu says that where legal and administrative requirements are concerned, a green bond is not very different to a standard bond.
“The only thing that’s different is the use of proceeds statement in the documentation, and there’s the green financing framework that you have to put in place, the cost of which is relatively small,” he explains. “You also need to get a second-party opinion on the framework.”
In addition, Liu says the process involves reporting on the impact of the projects funded by the financing. While this does take more work, he notes that there is generally a greater demand for this type of information from stakeholders, “so we are probably going to be producing this information anyway.”
Final thoughts
With some parts of the market more developed than others, it’s clear that more progress is needed in some areas. “There are a few things that we need the green product markets to do before things can develop further, and this is mainly around transparency, disclosure and standardisation of the terminology,” says Joshi.
But he also notes that if requirements become too onerous, investors may be deterred – “so it’s about getting that balanced approach.”
Meanwhile, although not all companies will be focusing on green or sustainable financing at this stage, there may be other steps available to them. Dukes, for example, notes that Drax has embedded ESG metrics into the company’s working capital programme.
And as she points out, a further consideration is that listed corporates that do not issue debt are still likely to be rated by one of the ESG rating providers.
She advises that companies should find out whether they have a rating, determine how this compares to their peers and take steps to improve the rating if necessary.
“While you may not be looking to issue debt, there is genuinely an increase in other stakeholders – whether that’s customers, suppliers or even future employees – that are looking at that type of information and assessing you against it,” she concludes. “You might not be getting finance on the back of it, but it’s still important to be able to say, ‘we are doing the right thing for the right reasons, and this is what we’re doing to improve’.
And if you do then decide to embed that into financing, you’ll get an easier life and will hopefully be appropriately rewarded.”
Acknowledgement
With thanks to Naresh Aggarwal for his assistance
About the author Rebecca Brace is a freelance business and finance journalist
This article was taken from the June/July 2020 issue of The Treasurer magazine. For more great insights, log in to view the full issue or sign up for eAffiliate membership