Green finance instruments are becoming more popular as companies seek to reduce their carbon footprint.
Currently the two main products on the New Zealand market are green bonds and green loans. Others may emerge as the pressure for sustainability grows from regulators, investors and consumers.
Green bonds have become a feature of the New Zealand debt capital markets landscape over the last few years and are being used to promote environmental and social initiatives. The range of acceptable purposes is diverse – from green buildings and eco-efficient product development to biodiversity and affordable basic infrastructure.
Examples are: Argosy’s bond to finance “green assets”, Auckland Council’s green bond programme to fund projects with positive environmental impacts, and Housing New Zealand’s framework which can be used to fund initiatives such as green buildings and pollution control, and for purposes of socioeconomic advancement – or a combination.
None of these products creates a default event if the proceeds aren’t applied to the nominated green or social initiative, but there would be significant reputational consequences for the borrower if that did occur.
As the market matures, we may start to see default events and/or pricing step-ups linked to the sustainability of the issuer together with increased reporting from the issuer on its ESG position. These protections are not required now but there would be significant reputational consequences for the borrower if the nominated objectives of the bond were not followed through.
New Zealand’s regulatory framework does not differentiate between green and other bonds and there is no prohibition on marketing a bond as a green bond without adhering to green principles or other recognised standards such as those provided by the Climate Bond Initiative. But any “green” claims will be subject to the fair dealing rules, including restrictions on misleading advertising.
The NZX has recently introduced green labels, allowing investors to easily find and track green investments and providing issuers with a central disclosure venue.
Still unresolved is whether a green bond can be issued as the ‘same class’ as an existing quoted non-green bond – meaning that the issue can be through a terms sheet rather than requiring a new regulated PDS. We expect more flexibility on this point in the future.
Green loan products issued by the banks fall into two categories:
- the proceeds loan, which looks like a conventional loan except that the purpose is restricted to a specific green project which meets the bank’s sustainability criteria, and
- performance linked loans which require that the borrower gets a sustainability rating at the outset from a recognised provider (such as Sustainalytics) and has this reviewed annually. A margin change will then be applied based on whether the rating goes up or down.
There is a cost to this review but it should not be significant if the company has established sustainability practices and reporting and is already collating the relevant information. Borrowers should be aware that any decline in their rating will result in an increase above the margin they would otherwise have paid if they hadn’t taken on a sustainability loan.
Any failure to provide an ESG report will also result in an increased margin. While borrowers obviously like pricing decreases, this benefit is often secondary to the contribution the green product makes to the borrower’s overall sustainability story.
The banks don’t currently get any capital relief for providing green products so any reduction on interest rate affects their profit. A package of green loans could be securitised or used as collateral by a bank as part of its own green fund raising.
Directors should be turning their minds to the impact of climate change on their company and the impact of their company on the environment. The costs of not doing so are rising and will continue to rise.
Australian Senior Counsel Noel Hutley observed in an opinion delivered in March this year that: “[R]egulators and investors now expect much more from companies than cursory acknowledgment and disclosure of climate change risks. In those sectors where climate risks are most evident, there is an expectation of rigorous financial analysis, targeted governance, comprehensive disclosures and, ultimately, sophisticated corporate responses at the individual firm and system level”.