The shine is beginning to come off environmental, social and governance bonds in Europe’s high grade corporate bond market just as the COP26 conference comes to an end.
The ESG bond market — that has this year almost guaranteed an issuer would print inside its conventional curve — is now making borrowers pay up to get deals away.
Syndicate teams said that only corporate issuers seem to be have been affected so far. Bank issuance, in which green bonds are still comparatively rare, is still giving borrowers a clear spread advantage over conventional deals.
“There’s no one reason that ESG deals haven’t been doing as well as they were,” said a corporate syndicate banker. “There has been an awful lot of supply, and it has come in thick blocks. So even if the supply/demand dynamic is in favour of borrowers, investors aren’t chasing deals anymore.”
The simmering down of investor interest comes as the COP26 meetings in Glasgow come to an end this week, with hopes high that money is going to be pouring into ESG investment in the coming years. Ex-Bank of England chief Mark Carney, for example, announced that the Glasgow Financial Alliance for Net Zero has mobilised $130tr of committed money to fund the world’s transition to net zero.
It is possibly the expectation of a flood of ESG trades that has made investors less keen to buy deals at negative concessions, according to two syndicate bankers, one of whom said: “We’re all expecting more green issuance on the back of COP26, I don’t think there’s a CFO anywhere who isn’t giving serious thought to how they’re going to do it.”
Deals that, earlier in the year, would have likely been roaring successes for borrowers in terms of spread have been far more lacklustre this week.
Once such example was Iberdrola, which brought a green hybrid on Tuesday. Green hybrids are something of a holy grail for green bond investors, as they offer the chance to pick up some yield in a corner of the market that is traditionally priced razor thin.
However, Iberdrola had to settle with paying a 10bp new issue concession on the €750m 1.575% perpetual non-call six year deal. Leads put this down to a few factors, mostly linked to the amount of supply expected next week.
By contrast, in February, when markets were packed with deals and investors had the entire year to buy more debt, the borrower printed a €1bn perpetual non-call six year deal with no new issue premium. That trade also yielded less than this week’s deal at pricing, at 1.45%, and came at the same time as Iberdrola printed a €1bn non-call nine year, also with zero concession.
“Borrowers should never come to the market expecting to print with zero concessions,” said a syndicate banker in London. “You’d never go into a shop and expect to be paid for taking stock away.”
Nonetheless, it “has been a bit of a surprise” that the spread benefit for printing ESG related debt has become harder to secure in the back end of the year, the banker conceded.
KPI loading won’t help
German chemical company Henkel also had a tough time in the ESG bond market this week. It launched a debut sustainability linked-bond via two tranches, a €500m no grow 11 year note and a $300m no grow five year Eurodollar.
The Eurodollar deal was a messy affair, although it did get done. It was launched at the same spread as initial price thoughts but Henkel had to settle for $250m, not the $300m it was aiming for. Syndicate bankers off the deal put this down to the borrower’s approach to the Eurodollar market, rather than anything ESG related.
The euro portion, however, also failed to impress. “It’s lacklustre,” said one syndicate banker, echoing the sentiment of two other bankers off the deal. “A €900m book for a €500m no grow is not going to be pleasing to anyone.”
This was a far cry from Swedish fashion retailer H&M’s €500m no grow SLB debut in February, which found €5.4bn of demand at guidance and got the market buzzing over the prospects for other bond debuts that might use the sustainability-linked structure with equal aplomb.
Henkel’s struggle in the market was all the more apparent because the trade was bulging with key performance indicators. There were four in total, two specifically for the euro tranche, a shared one between the euro and Eurodollar, and another for the dollar tranche. Many deals have been successful this year with just one KPI.
“Investors don’t care about KPIs,” said a head of syndicate in London. “They look at them, but they don’t really care. They just want to see that something is being done about greenhouse gasses and that’s enough for them.”
Maturing market
Even Dutch telecoms company KPN, which printed its sector’s first SLB this week in a €700m 0.875% November 2033 deal, did not set investors' desires alight with a focus on Scope 3 emissions — by far the most difficult to record and reduce of the three main emission sub-categories.
The issuer paid a 2bp new issue concession to get its deal away, with a final book of €1.1bn. That cannot be called bad for the borrower, but it was not the deeply negative premiums seen earlier in the year for similar deals.
“As the market matures, people are going to be less happy paying more for ESG bonds,” said a syndicate banker in London. “You’ve got major issuers now who have made a big splash saying they’re only going to issue SLBs.”
Instead, the syndicate banker said he could envision a market where borrowers are made to pay more if they want to bring conventional deals.
“What you’re really getting for an ESG deal is more transparency,” said the syndicate banker. “Investors can look at a corporate and know they’ve got a plan in place for the next five, 10 years, and a route of how they’re going to do that.”
ESG bankers have said in recent weeks that the idea of a greenium is likely to come to an end as green finance becomes ubiquitous.
While the corporate market seems to be facing a reckoning with ESG funding, the FIG market is still happy to make ESG deals more expensive, despite a bloom in issuance this year.
ESG issuance only made up 12% of the euro FIG market in 2020, and this has shot up to 25% this year. Issuers are still bringing ESG structures to new, major markets, with NatWest selling its debut green sterling transaction through its holding company last week, raising £600m of seven year non-call six senior debt.
The deal still paid a premium of around 3bp-5bp, but this was well inside the 5bp-10bp concession seen on other recent sterling deals in the FIG market.
