Wesfarmers breaks green bond ground

Australia’s sustainable bond universe blew past $15 billion in 2020, but still lags the European market by four or five times on a relative basis, says Realm Investment House’s Adrian Chow.

Locally, sustainable bonds comprise just 1% of the total bonds outstanding, versus around 5% of their total bond market in Europe. “So there’s still some catching up to do here in Australia,” Chow says.

What is a sustainability-linked bond?

So, what exactly are sustainability-linked bonds (SLBs) and are they different to green bonds? Green bonds have a defined remit where issuance proceeds are to be used for environmental or “green” projects. The other major difference is that green bond issuers aren’t held accountable in the same way as sustainable bond issuers. As Chow explains, the lack of contractual protections for the bondholder of green bonds means the company faces no direct repercussions if they fail to deliver on the defined remit.

On the other hand, SLB issuers agree to link the bond directly to various sustainability targets. And if they fail to do this, the company incurs a higher coupon, in favour of the investor.

Sustainability-linked bonds (SLBs) are a new type of general corporate purpose bond in which investor coupons are tied to an issuer’s sustainability key performance indicators such as decarbonisation.

SLBs have four core components:

1. A credible KPI
2. Ambitious sustainability performance targets
   
3. Meaningful changes in bond characteristics
   
4. Verification and reporting mechanisms
   

Australia’s first SLB issuance was that of Wesfarmers in June this year, an offer that was 2.5-times oversubscribed. Chow chalks this up to a couple of things:

• The strong fundamental view on Wesfarmers as a company, having proven highly resilient to the pandemic
• The scarcity premium around Wesfarmers bonds, which have not been available locally since 2015

“And for us, the sustainability-linked element was the cream on top,” Chow says. Though Chow and his team participated in the initial book-build, the fixed income fund manager was ultimately priced out. But while this was just the first such issuance in the Australian market, he is confident it is far from the last.

Especially given the noise that accompanies the popularity of ESG, it’s important not to lose focus of the fundamentals. This is a point emphasised by BNP Paribas, one of the lead managers in a sustainability-linked bond issued by another Australian company, engineering firm Worley (ASX: WOR), last month.

Like the Wesfarmers issuance, the Worley SLB was oversubscribed, this one by around 3-times, achieving a final size of around 500 million Euros. A key distinction here is that the Worley example sees an Australian company tapping the European market for capital, while the Wesfarmers bond is the first-of-its-kind in the Australian market

“The reception to the transaction was aided by the sustainability-linked element but also by investor assessments of Worley’s credit and overall transition strategy,” says Kate Stewart, managing director and head of debt capital markets at BNP Paribas Australia.

The Worley SLB ticked all the boxes of the company’s stringent sustainability framework, which includes a KPI based on Scope 1 and 2 emissions for entities and assets controlled by Worley, and a sustainability performance target to reduce absolute Scope 1 and 2 emissions by 50% by 2025 from a 2020 baseline. This aligns with Worley’s 2030 net-zero emissions target.

Speaking more broadly about the outlook for SLBs in the local market, Realm’s Chow believes the Wesfarmers issuance is just the first of many.

“This is a definite positive for investors, in seeing issuers held accountable for their sustainability goals,” Chow says.

“Over time, we will see more sustainability-linked bonds in the local market and greater diversity of issuers in this space.”

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