In advance of the Bonds, Loans & Sukuk Middle East event in Dubai in March this year, the Bonds & Loans team sat down with Jean-Marc Mercier, Global Head of DCM and Farnam Bidgoli, Head of Sustainable Bonds at HSBC to discuss key trends in the global sustainable finance market, and take a look at why the Middle East may be on the precipice of a significant shift towards ESG that could see more CFOs and treasurers take the plunge and issue green.
Bonds & Loans: Whether by geography or sector, where do you see the biggest growth opportunities for green bonds specifically and sustainable finance more broadly?
Jean-Marc Mercier: We are now looking at a market that is roughly USD200bn, which has grown from virtually nothing over the past five years, so the pace of expansion has been tremendous. At a global level, we’ve seen a number of large sovereigns come to market including the Republic of Indonesia, Poland, Ireland and France; sub-sovereigns like Mexico City and the City of Cape Town; financial institutions like First Abu Dhabi Bank and corporates like Repsol & Telefonica tapping into this market.
Although we haven’t historically seen high levels of interest from the Middle East, we have been encouraged by the uptick in interest towards the segment in recent months, and feel confident that we will see a rise in green or ESG-linked issuance from the region this year.
Farnam Bidgoli: There is a significant policy focus in most of the region’s largest economies, including Saudi Arabia, the UAE and Egypt, on renewable energy specifically and sustainability more broadly, and that is translating into an increased interest in the sustainable finance market as well. It is prompting many to start recognising that we need private capital alongside public funding to achieve some of those goals and targets.
We continue to see significant opportunities in the corporate sector. In 2018, corporates only represented about 25% of ESG-linked issuance overall, and there are still quite a few sectors that haven’t taken their first steps yet. But what you often find is that once a pioneering company decides to take the plunge, others follow. A good example of this is Telefonica, which at the end of January this year became the first telecoms operator to issue green bonds; they were followed almost immediately by Verizon in the US, and Vodafone – which recently announced the launch of its own green bond framework, meaning they will likely come to market in the near future. Telefonica really opened up that segment of the market to sustainable finance. We saw a similar trend in food and consumer goods in 2018. I think we will start seeing sustainable finance move from being limited to the energy and real estate sectors, and start to be embraced by a broader range of private and public sector borrowers.
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Bonds & Loans: What is your sense of the size and pace of growth of the dedicated ESG-focused liquidity pool? Do you think traditional asset managers are under more pressure from investors or regulators to prioritise ESG in their investment analysis methodology?
Farnam Bidgoli: ESG is top-of-mind for asset owners and managers, and it is being driven by a number of different factors. Policy is one of them, especially in Europe, where we are seeing a shift towards the integration of environmental and social factors into investment decisions. In France, for instance, you have Article 173, which obliges asset managers to disclose their ESG policies and analyse the climate risk of their portfolio. This means that any borrower thinking about tapping into French liquidity will need to consider how their own corporate activities are framed within that investment philosophy.
It isn’t just being driven by regulators; most investors we speak with say that ESG is increasingly a factor in almost every single RFP they encounter. This means that whenever asset managers look to win mandates, they are increasingly being asked how they are incorporating ESG into their wider investment methodology, whether that’s being achieved through a thematic portfolio approach, or an internal integration process that gives preference to green or sustainable bonds, or borrowers that have strong ESG-related profiles. It has come to the forefront for major asset managers and owners. We estimate there to be about USD120bn of ESG-linked bond funds, including both labelled green bond funds and themed funds. But when you look at the signatories to the UN PRI’s Principles for Responsible Investment, a commitment to incorporate ESG factors into investment decisions, they represent over USD80trn in AUM. That’s USD80trn in AUM that is meant to be invested with consideration to environmental, social, and governance risks and opportunities.
Bonds & Loans: HSBC took a leading role in structuring the first green-accredited sovereign sukuk. What were the main drivers behind blending features from the two types of credit instruments – green bonds and sukuk – together in one package? And what were some of the challenges you encountered, if any, of structuring a ‘world’s first’ in that sense?
Jean-Marc Mercier: The drivers for the Republic of Indonesia were fairly clear. It wanted to finance a wide range of green activities, including increasing the use of renewable energy and energy efficiency, raising climate resilience and the use of sustainable transport and agriculture, and developing a range of other green assets – waste-to-energy and eco-friendly buildings, for example.
The transaction was a first for the green bond segment and was very well-subscribed by a broad group of investors – including dedicated shariah-compliant investors, which bought close to 30% of the 5-year tranche and nearly a quarter of the 10-year. On the back of a strong orderbook, the transaction saw a 30bp tightening from initial price guidance, pointing to the strong reception from the market.
Farnam Bidgoli: There was definitely some education that had to take place, but nothing insurmountable. We needed to familiarise green investors with the sukuk structure, and give sukuk investors comfort about green. For green investors, the most important thing is the use of proceeds – and the sukuk structure doesn’t change this: we are still going to see proceeds from the transaction going to green projects; there will be regular reporting on how the proceeds are used and the impact of those projects.
While there was a bit of education at the outset, the fact that Indonesia has now been in this market twice over the past year in Green format should give more traditional sukuk issuers from other geographies or sectors comfort that they can tap into this market and reap some of the benefits of added diversification and investor exposure.
Jean-Marc Mercier: Indonesia’s tapped the international markets via its 2nd green sukuk in February this year reflecting investor demand. Investors value issuers looking at green and ESG as a core part of their funding plans with a commitment to tap markets in a consistent and transparent manner. Given sukuks are typically asset-based to begin with, the tagging and monitoring of use of proceeds – typically one of the more challenging aspects of setting up and managing transactions after they have taken place – is often already implied in the structuring and issuance of sukuk to begin with.
When we first hit the road with the Republic of Indonesia, there were a range of questions from investors around the government’s convictions in the area of sustainability and their intention to tap this market on an ongoing basis. On their most recent green sukuk, the government benefited from a 3rd party review with reports on how they’ve used their proceeds and the impact of those investments, which has again helped to familiarise investors with green instruments and to show borrowers that there is real value in developing green frameworks and robust tagging and reporting capabilities.
Both of these factors may not lead to an easily quantifiable benefit in terms of basis points, but certainly do translate into long-term investor diversification, and how it trades in the secondary market.
Bonds & Loans: The MENAT region has seen less than a handful of green bond issuance, despite the region’s shifting emphasis on renewable energy, sustainable transport infrastructure, and other areas of the economy that lend themselves nicely to sustainable finance. But why is sustainable finance still lagging in the region? Do you think, given the prevalence of sukuk in the MENAT region, that the ‘green sukuk’ could change that?
Jean-Marc Mercier: That’s what makes the Indonesian sovereign sukuk one of the more interesting developments for this region. Packaging ‘green’ and ‘sukuk’ together opened up many conversations in the Middle East, particularly given the size of the sukuk investor based in the region, and that the sovereign has hit the market again with a very similar green transaction has bolstered its appeal. But beyond that, the fact that we continue to see a range of ‘firsts’ across the sustainable investment landscape globally continues to give confidence to borrowers in the Middle East who may be looking to come to market – in large part because all of those ‘firsts’ were extremely successful. It shows that the work – in terms of transparency, data collection, setting up a reporting framework and seeing it through to implementation – is worth it.
Farnam Bidgoli: Early scepticism was driven by the fact that people were searching solely for additional pricing benefits – and were trying to understand the potential value or benefits of issuing in this format in those terms. What we’ve seen normally is that green bonds price in line with conventional issuance.
But that being said, although the pricing advantage might not be there, borrowers are becoming increasingly attuned to the benefit of investor diversification and growing investor interest in ESG. We have seen a significant increase in the number of US and European investment funds asking for sustainability-related data, even on conventional transactions; investors are applying pressure to issuers to think about issuing green bonds, which is accelerating the growth of the segment.
We are also starting to see more awareness of this in other product segments, too. For example, in October last year, DP World secured a USD2bn green shariah-compliant loan which has an interest rate linked to the company’s carbon emission intensity, a first for a corporate in the Middle East. Climate risk more broadly is something that more banks are concerned about. We are in the process of analysing our own portfolio for climate risk in accordance with our commitments to the Task Force on Climate-related Financial Disclosures (TCFD), and we know a number of our clients are doing similar things. This is trickling into our lending process as well. HSBC has for instance been active on a number of sustainability-linked revolving credit facilities with clients. We are including ESG into the lending conversation on a more frequent basis, and it can lead to a difference of one or two basis points – but more importantly, it contributes to a further alignment between ESG commitments and the price of borrowing.
Bonds & Loans: If you could bust any myths and give them a sense of what to look out for, how would you advise borrowers taking their very first steps in the sustainable finance area?
Farnam Bidgoli: The most important thing to consider is the use of proceeds and project identification. I always flag to issuers that this is a very collaborative market. Investors are very forthright in providing feedback on what use of proceeds qualify in terms of their own eligibility, and we at HSBC are always willing to work with them to make sure that they come to market with a credible framework that investors support. There is often this fear around whether they will be ‘green enough’ or ‘sustainable enough’, and it’s important to note that there is flexibility in the market. Investors want to see a diverse, broad market and are accepting of issuers that are transitioning, as long as their commitments are credible.