New directions for Australia's green bond market
Increasing emphasis on ESG in the wake of the pandemic looks set to power growth for green bonds and provide lift-off for further sustainability-focused bonds.
Australia’s green bond market has experienced exponential growth since the World Bank issued its first AUD 300 million green Kangaroo in 2014.
The country’s cumulative green bond issuance has grown to around AUD 15.6 billion to date. But, with COVID-19 putting the brakes on much of the economy, what can we expect from the green bond market as the country plots its path to recovery?
This was a central question in the recent Clean Energy Finance Corporation (CEFC) webinar, Beyond the pandemic: can booming green bonds maintain the pace?, hosted by CEFC Director – Investments, Grace Tam.
Michael Chen, Head of Sustainable Finance at Westpac Institutional Bank, was part of the discussion panel and spoke about the resilience of green bonds during the pandemic, as well as their broader growth outlook. He was joined by Gavin Goodhand, Senior Portfolio Manager and Co-founder of specialist investment manager Altius Asset Management, and Bridget Boulle, Head of Production and Content at the Climate Bonds Initiative, who provided global insight into the state of the green bond market.
Market goes green
Created to fund low-carbon assets, such as renewable energy or green buildings, the world’s first green bond was issued in 2007 by the European Investment Bank. The 2015 Paris Agreement on climate change saw the market accelerate, with issuances exceeding USD 80 billion in 2016. Last year, the global green bond market reached just over USD 250 billion.
The Australian market has also seen rapid growth, with the biggest issuances to date coming from banks, state governments and corporates. Westpac is the largest financier to greenfield renewable energy projects in Australia and was part of the world’s first green loan to be certified under the international Climate Bonds Standard – an AUD 192 million loan to ASX-listed power generation development company Genex.
Commenting on the market’s progress in Australia, Chen said growth was aligned with a greater focus on environmental, social and governance (ESG) standards.
“When I reflect on my conversations with issuers a few years back, their questions would be around pricing benefits and why they should put in the work [for green bonds],” he said. “In my meetings with issuers these days, the finance team walks in with a greater appreciation of the importance of the ESG issue.”
Investor expectations may also be contributing to market growth, with funds like Atlius integrating ESG into their financial metrics when examining any issuer. Goodhand said it had also introduced a green bond policy framework.
“We look at how the organisation strategy is aligning with its overall sustainability framework,” he said. “What assets are being included within that portfolio? Are they aligned with Paris? Who's selecting those assets? How are they monitoring the funds when they're coming in, because there's got to be a segregation of assets under any use-of-proceeds bond,” he said.
Goodhand noted that a growing demand for transparency is placing more focus on reporting for green bonds.
“Investors want to see impact,” he said. “When an issuer comes to market with a green bond, they need to go through many stages before it becomes an eligible security for all the funds that we look after.”
“We’re investing in innovative green bonds to provide additional strength to this rapidly growing sector,” Tam added. “Investment products that provide market returns alongside positive environmental outcomes are an increasingly attractive way for institutional and wholesale investor capital to support the transition to a low emissions economy. We are at the cusp of a long-term trend towards sustainable finance and green bonds will be a key part of this transition.”
The COVID-19 effect
While issuance of green bonds was hit by the COVID-19 crisis, Boulle said the global market has “reacted quite strongly”.
“At a push, we think issuance this year may reach around USD 240-250 billion, just under last year's record figure,” she said. “It has also been bolstered by other types of debt formats, such as social bonds and sustainability bonds, which we've seen emerge along with the green format.”
Chen noted that while the pandemic disrupted Australia’s green bond market in the first three quarters of the year, it also underscored its resilience.
“During the early months of COVID-19 there was extreme volatility and dislocation and we saw that green bonds were more resilient because investors were typically more the 'buy and hold' type,” he said.
Despite slow progress throughout much of the year, Chen pointed to a rapid turn around for Australia’s green bond market.
“A lot of finance teams pushed back green bonds and sustainable finance plans earlier in the year while they were getting their house in order and making sure they had adequate liquidity,” he said.
“We're now seeing numerous green bond issuances via state governments like New South Wales and Queensland, as well as corporates. I think the market is coming back and, based on our discussions with clients, I expect a strong year ahead.”
The market may also be buoyed by new sector guidelines that will expand the pool of green bond issuers.
“An example of this is the Waste Sector Criteria that the Climate Bonds Initiative recently released,” said Chen. “Now that we’ve got good, globally accepted definitions around what exactly green looks like in the waste sector, I expect we’ll see some issuances in that space.”
What’s next for green bonds?
With ESG factors becoming increasingly important to investors, Goodhand expects green bonds to become more attractive.
“I think investors are starting to see a differentiation of sectors driven by ESG concerns,” he said. “It's starting to be incorporated into pricing of new debt that's coming into the market.”
Boulle expects to see developments in transition bonds, which are targeted at carbon-intense industries that require financing to reduce their greenhouse gas footprint.
The Climate Bonds Initiative recently published a white paper that presents a framework for identifying credible transitions aligned with the Paris Agreement.
“There have been some transition bonds issued in the market, but there was no clear definition of what it means,” said Boulle. “Is it a halfway-house to green? At the Climate Bonds Initiative, we’ve been of the view that if a company is making a transition in line with the Paris Agreement, they should be called green, whatever their starting point, and their bonds therefore could be called green.
“However, our research in developing the white paper showed that there was a useful distinction to be made for activities that do not have a long-term role to play in the low carbon economy and those that do.”
Boulle added that while guidelines are expanding to include more sectors, such as waste, activities in some sectors, such as coal, lack a pathway to de-carbonisation.
“There’s a transition away from coal rather than transition within the activity itself,” she said. “The transition label can also be used for [sectors] that are making a substantial contribution to the Paris Agreement – zero carbon by 2050 and halving emissions by 2030 – but that do not necessarily have a long-term role to play post-2050.
“The other way we see the transition label being useful is for those that will have a long-term role to play – like steel, chemicals and cement – but we have a limited idea of what that looks like, so far. ”
Aviation is an example of this, said Boulle: “We know that we're going to need to fly post 2050, but there's no clear de-carbonisation pathway yet. I think we’ll see more happening in the transition space, as well as the creation of taxonomies around the world and a harmonisation of global definitions around green,” she said.
Chen is also bullish about the future of transition bonds. “There's a huge amount of issuers in the hard-to-abate sectors that we need to bring along and I’m looking forward to seeing the labelled transition market flourish,” he said.
Despite the emergence of new labelled bonds, such as transitions, Chen expects the focus on green to intensify post-COVID-19.
“In the broader sustainable finance market, I think green will continue to be the most prominent format, purely because of the scale of the decarbonisation path to get to net zero,” he said.
“Even in broader sustainability bonds, most of the activities that the proceeds are used to fund are green, so the green story will continue to boom.”
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