22 August 2018
Times are a-changin' in the bond market. Companies with strong environmental, social and governance (ESG) ratings stand to have privileged access to the capital markets. A universal 'green treasury' approach is needed to reap the economic and social rewards, says Arthur Krebbers
Bonds have come a long way in the last few centuries. Their latest incarnation, the 10-year old green bond market, saw $156 billion in primary issuance last year, according to the Climate Bonds Initiative. While only a fraction of the $90-plus trillion bond market, green bonds can be a force for good when proceeds are genuinely used for climate change solutions.
But, by themselves, green bonds are no panacea. They risk limiting a company's sustainability agenda to a mere portfolio of environmentally-friendly projects. Internal and external stakeholders are demanding more from companies. Management boards are therefore seeking to make sustainability part of their firm's DNA, including the finance department.
Most of these companies' debt investors are already on the case, using sustainability rankings to drive bond purchase decisions. 76% of Europe's largest bond fund managers have signed the UN Principles for Responsible Investment, committing them to "incorporate ESG issues into investment analysis and decision-making processes".
We see the results of this pledge across the primary markets. Investors do not necessarily want to invest in new debt offerings from well-known blue-chip companies if their environmental, social or governance profile is not up to scratch. ESG laggards run the risk of a 'pariah' status.
More stringent ethical investment criteria are impacting bond market dynamics at a critical inflection point. The wind-down of quantitative easing in both the US and the EU is leading to a normalisation of supply and demand for bonds, enhancing the influence of investors.
Companies are therefore increasingly paying heed to the need to be a 'green leader'. This, in turn, is forcing a treasury rethink. A typical treasurer would instinctively stay far removed from this green agenda, seeing their mandate as exclusively focused on the smooth functioning of the organisation's finances.
"Investors do not necessarily want to invest in new debt offerings from well-known blue-chip companies if their environmental, social or governance profile is not up to scratch".
However, such financial 'smoothness' is starting to become dependent on the company's greenness. A compelling ESG profile is an increasingly important prerequisite for strong debt market access. Those with weak sustainability scores may have less flexibility in terms of timing and other parameters (such as tenor and coupon rate) when issuing bonds in the wholesale markets. As a result, their financing could be more expensive.
Issuing a green bond is just one way of flagging a firm's sustainability profile. But investors are increasingly looking at the whole package, including corporate ESG (or sustainability) ratings, in their assessment. This necessitates a green corporate treasury strategy.
The speed-dial of a green treasury now goes beyond Fitch, Moody's or S&P to the likes of Sustainalytics, MSCI and ISS-Oekom. They target both a decent credit rating as well as an ESG rating, eg. 'in the top 25% of our sector'.
This entails a more holistic dialogue. Questions around liquidity and funding policy – a treasurer's normal comfort zone – are substituted for enquiries on green procurement programmes, board diversity and whistleblower policies. It introduces a range of new Key Performance Indicators: interest coverage ratios are complemented with carbon dioxide emissions, and so on.
It also requires improved internal collaboration. Historically, sustainability and finance functions have been in parallel worlds speaking a different language. But, as treasuries focus more and more on the quality of sustainability data, new cross-functional working groups have emerged, with budgets made available to improve internal systems and analytics underlying green reporting.
Not everyone, however, is ready to take this leap, with various industrial and commodity sector treasurers preferring to take a conservative approach. They are cognisant of the risks of overstating their green credentials while underlying environmental standards and priorities remain in flux. Instead, they would rather see other first movers in their sector lead the way and set an appropriate benchmark.
Yet waiting is becoming a less and less palatable option. Besides investors, there are a range of other pressures forcing treasurers to show their sustainability cards, including regulators, governments, NGOs and shareholders. And, perhaps most persuasively, their own boss. For many ambitious CFOs, a green bond is not enough: they want their finance function to adopt a credible green strategy. Green is, after all, good.
Dr. Arthur Krebbers is green finance co-ordinator at NatWest Markets