Private sector decarbonisation goals could be in “jeopardy” because of the turn towards more polluting energy sources, EU financial markets regulator Esma has warned in its latest risk monitoring report.
This has also created fresh scrutiny for green financial products, it said. In particular, some of the targets hit by the energy crisis determine repayment rates on a new-ish asset class, sustainability-linked bonds.
For today’s edition, I interviewed the head of finance at Italian state energy company Enel, about its decision to issue €1.5bn of sustainability-linked bonds despite concerns that Italy’s use of coal to reduce dependence on Russian gas has hit its ability to reach climate targets on existing issuances.
First, read on for Simon’s story on the hundreds of companies ill-prepared to comply with a landmark new law on deforestation.
Companies exposed to deforestation should take note of another Achilles heel for sustainable finance mentioned by Esma: advertising standards authorities, financial regulators and the public all threw greenwashing accusations around last year, creating significant risk for investors and issuers. “Rebuilding trust will take some time and require greater transparency efforts,” the regulator wrote. (Kenza Bryan)
Companies are ill-prepared for the EU’s new deforestation law
A landmark new law from the EU, banning the import of products linked to deforestation, has sparked a furious reaction from the Indonesian and Malaysian governments, which are fearful of the impact on their exporters. It’s also going to create headaches for some of the world’s biggest companies, who will be required to prove that their goods have not been produced on land that was deforested in recent years. And that, according to Niki Mardas, executive director of the non-governmental group Global Canopy, is a very good thing indeed.
Even after years of public pressure on companies over this issue, progress remains seriously inadequate, a Global Canopy report published today suggests. It looks at the 150 financial companies and 350 non-financial ones that, according to the researchers’ analysis of public data, are most exposed to deforestation risk in their supply chains. Of these 500 companies, 201 still don’t have an explicit public policy on any of the commodities to which they’re exposed — an improvement of just nine since last year.
“It’s striking, really, that you’ve got some very large companies who are very closely linked to these issues, that still have got nowhere on this,” Mardas told me.
The report focused on the six commodities that are most strongly linked with deforestation: palm oil, soy, beef, leather, timber, and pulp/paper. It highlighted some significant differences in terms of how companies treated various commodities.
Of those working with palm oil, more than two-thirds had made a public commitment around related deforestation risk. For leather, the corresponding figure was just 28 per cent.
The disparity reflects the lack of public attention paid to the environmental impact of cattle rearing compared with palm oil production — even though the former is a bigger driver of deforestation, Mardas said.
Nervousness of public pressure could also help explain why the “real economy” companies in the study performed better than the financial institutions that fund them. Sixty-nine per cent of the non-financial companies had publicly declared a deforestation policy for at least one commodity that they were exposed to, against just 39 per cent of the financial ones.
But when the new EU law comes in, it will have serious implications across the corporate sector. While financial companies will not initially be required to report on their deforestation risk (a review of this will follow after two years), they’ll need to pay serious attention to how it affects their clients and investments. The law is expected to come into force as soon as late 2024.
“We’ve now got the point where, if you’re an investor in a company that will have to comply with new EU due diligence legislation — which is most of these big companies — and they’ve got nothing on deforestation, I think you now have to be asking some quite serious questions around compliance,” Mardas said. (Simon Mundy)
Enel ploughs ahead with €1.5bn SLB issuance despite Italian coal revival
Alessandro Canta, head of finance and insurance at Enel, Italy’s state-owned energy provider, is part of the exclusive group of people who can take credit for inventing an asset class.
Canta oversaw Enel’s launch in 2019 of the world’s first sustainability-linked bond — a general-purpose debt instrument that makes issuers pay a higher interest rate on their debt if they fail to meet a goal related to climate or sustainable development.
The quirky bond was meant to address a flaw in the booming market for “green” or “social” use of proceeds bonds: namely that they raise money for individual projects and therefore favour larger issuers. SLBs can be issued by any company, however small its green investment plans, and however high its carbon emissions.
But as I reported in a deep-dive on the topic yesterday, the philosophy behind SLBs has rubbed up against tough market conditions and concerns that companies are incentivised to choose weak targets with low penalties. Issuances fell 37 per cent to $60bn last year after rising tenfold to $95bn in 2021.
And even with relatively easy targets, the turn towards coal in Europe as a result of Vladimir Putin’s war in Ukraine has threatened to throw more companies off course than expected. A number of Enel’s own bonds are tipped to “step up” (an increase in the coupon rate) this year or next year.
But the energy group will stick to its 2019 commitment that all its future bond issuances will be sustainability-linked, Canta told Moral Money — a decision that he said was made possible by the EU’s increasingly serious approach to climate policy.
“We now see a very unique convergence of interest by regulators, by authorities, by government, in order to decrease the dependence [on] fossil fuels,” he said. Thanks to “the speeding up of the permitting process and investment that everybody is doing in Europe, we see this dependence on fossil fuels in any case decreasing in the medium and long-term.”
In a sign of renewed bullishness, investors had yesterday placed around €4bn of orders for a €1.5bn sustainability-linked bond issuance that Enel is bringing to market next week.
The European Central Bank in 2021 started accepting sustainability-linked bonds as collateral for credit operations and for its own purchasing programme, on the condition that these bonds be tied to UN Sustainable Development Goals or the EU taxonomy. This ruling was a “blessing”, and “made of this product an asset class”, Canta said.
For Canta, it is crucial to achieve a lower cost of capital in exchange for the quarter percentage point yield bonus offered to investors if Enel misses its targets. The targets spread across the two tranches of the bond include achieving zero emissions by 2040 for direct and indirect emissions from its power supply.
“We have been very clear and fair with investors that we will never give in optionality for free . . . The moment we put a step-up we want to receive a greenium [lower cost of capital] upfront,” Canta said. The group said it received a discount of a fifth of a percentage point on its 2019 issuance.
Josephine Richardson, head of portfolio strategy at the Anthropocene Fixed Income Institute, a not-for-profit, argues that focusing on bond yields misses the point. Step-ups act as a unique “hedge” against the risk of poor environmental performance hitting a company’s credit performance and therefore the price of the bond, she told me. SLBs are a “more powerful product, with a much clearer transfer of value between the issuer and the investor” than green bonds, she added.
Regardless of their reasons for buying the bonds, investors are pricing in a 72 per cent chance that Enel’s bond linked to its 2022 target will step up, according to Richardson. Canta said this risk was not a “major concern”.
But he was less bullish on SLBs linked to achieving carbon intensity targets in 2023, a measure of carbon per unit of output. Achieving this would require a steep drop in Italian coal usage to prewar levels this year, Barclays estimated last month.
Canta said: “We have to take into consideration what the government in Italy has asked us to do in order to secure the stability of the system, and provide electricity to the system itself … We don’t know if we will be respecting the targets or not.”
One of the biggest concerns about SLBs is the creeping introduction of “force majeure” clauses, which allow investors to wriggle out of the step-up. France’s AFTE, an association of treasurers, published a blueprint for what such a clause should look like last April.
Enel has previously issued bonds with this clause, but Conta ruled out invoking this. “In order to be reliable I think it is not appropriate to try not to pay . . . it is a question of being investor-friendly and demonstrating you are serious.” (Kenza Bryan)
Smart read
Conservative commentator Oren Cass sifts some disturbing data on the increasingly squeezed US middle class. In 1985, he points out, a US man could afford a comfortable middle-class life on 40 weeks of income from a typical full-time job. Today, the same lifestyle would need 62 weeks of income — “which is a problem, there being only 52 weeks in a year”.
Read the full article here