Fishing for Greenium

Holiday season was in full swing in the European High Yield market throughout August, unsurprisingly we have no green deals to report on. This downtime has allowed us to review the booming Green & Sustainability-linked space and discover what trends Issuers are following in order to steer their businesses towards a sustainable future - or in some cases just to catch the green premium.

With cumulative issuance at €20.1bn YTD, we have seen monumental growth compared to 2020 where ~€2.7bn just was recorded across the European markets. In this time instruments at issuers disposal have broadened to include social, transition and sustainability-linked bonds (SLB), but by the use-of-proceeds green bonds still represent the largest segment, featuring in 58% of deals since January 2021. Other than being the go-to way to pay for green projects, this method also requires less stringent KPI reporting and the absence of margin ratchets which are found in SLBs.

We’ve often found it difficult to judge the size of green premiums and the challenge becomes even harder when determining whether there is a greater premium in Green or Sustainability-linked issuances.

We demonstrated in our first edition of Sustainable Junk that Telecom Italia’s Green Bond exhibited greenium features when comparing the average yields between past offerings. The likes of Hapag-Lloyd, ZF and Arcelik have also secured their lowest financing packages to date - all whilst being in the backdrop of the Covid-19 pandemic.

The concept of a premium on green issuances compared to regular HY bonds is peculiar. If both issuances have the same degree of default risk then why should one be superior? This can be justified by higher demand. We’ve seen demand oustrip supply in the first half of the year, with the majority of deals oversubscribed, allowing for more aggressive spread compression. Green & SLB’s also incorporate a ‘sustainability’ factor. Sustainability should mean the avoidance of existential risk and therefore warrant a premium.

Investors should still be cautious of sustainability-washing schemes which may put their investment in jeopardy. Four areas that have raised red flags include; Climate-related KPIs; focus on emissions scopes; whether the KPI’s reflect true business-related sustainability issues; and whether targets are independently verified.

Green Standard

Although the materials sector, which mainly includes packaging companies, has seen the greatest chunk of green issuance, there is a fairly even split amongst industries - proving that the green label can be marketed pretty much anywhere.

Firms in the same industry often mirror their green financing packages, the real estate sector being a prime example. All five issuers debuted the EHY market in the first half of the year, each marketing a Green Bond with proceeds going towards eligible green projects including the construction of green buildings.

Unlike the deal structures, the KPIs chosen showed few similarities. SIGNA and Neinor Homes both use the BREAAM certification, whereas Via Celere and AEDAS Homes use Energy Performance Certificates (EPC’s) to verify green buildings.

In Via Celere’s case they may finance developments achieving EPC ratings of A, B, or C but AEDAS is restricted to ratings of B or above - which S&P constitutes as a Green Building.

A classic example of there being no standardisation in this segment.

Cruising

An uptake in green labels was applied to deals in the container shipping segment. Hapag-Lloyd and Ship Finance international (SFL) both chose green financing options, joining the drive towards a healthier shipping industry. SFL’s ESG efforts were lackluster however, their report spans a mere 19-pages and contains no set emission targets. Importantly this means they aren’t aligned with the Paris Agreement.

We noted in our ESG shipping piece incumbents will look to use low or zero-carbon fuels to meet IMO targets, with Maersk opting to run new ships on “green” methanol. As well as being a production challenge, shifting to greener fuels will have a direct impact on costs. Tightening regulation on fuel consumption, like the IMO sulphur emissions regulation which came into force last year, may also leave firms with stranded assets in the future. However, the industry is historically known for its slow approach to regulation in this area.

We crowned CMA CGM leader in ESG practices in Levfin shipping due to their comprehensive reporting and 2050 carbon neutrality target which aligns with the Paris Agreement. Although the group has contributed towards environmental efforts, through the launch of low-carbon shipping using biomethane, they haven’t yet chosen to issue green labelled debt.

CMA CGM’s management recently announced the proposal to redeem it’s 5.25% Jan-25’s at 101.313%. We believe their comprehensive reporting, which includes scope 3 emissions and details of specific low carbon technology, directs the company's operations to be aligned with emission reduction KPIs that could be used in a SLB deal.

Raffi Reffi to go green

Looking forward, as detailed in our recent Raffinerie Heide write up, the Germany-based refiner is set to launch a refinancing of its €250m December 2022 SSN’s imminently (prior to Q3 earnings), which is likely to include a green/sustainability linked element in relation to the company’s “industry leading” decarbonisation agenda.

During their Q2 earnings call, management spoke at length on their hydrogen production, biofuel, and carbon capture projects - although with unfavorable working capital dynamics and €110m in deferred taxes left to pay before year end, how the company intends to stump up the capex for these projects in the near term remains to be seen. It says it hopes to receive substantial government grants, but detail is light. Scope 3 emissions from burning oil and fuel produces 12 times the emissions of the extraction and refining processes, but refiners remain major emitters. It will be interesting to see to what extent Heide transitions away from traditional oil refining.

Leveraged Loans

With a predictably subdued Summer month in Leveraged Loan land, 9fin has turned to reviewing trends in 2021 issuance. Total issuance for Sustainability Linked Leveraged Loans sits at over €36bn YTD; significantly outstripping HY’s €20.1bn and a marker of sponsors’ appetite to both take advantage of available greenium and meet rapidly developing green/sustainable investment guidelines internally. Total issuance can be broken down by broad industry as follows:

The materials sector dominates even more heavily in YTD Sustainability Linked Loans (vs High Yield which saw a more even industry spread), holding a 28% share with sponsored chemicals issuers such as Titan, Nobian, Lonza Specialty Ingredients and Kloeckner major contributors. Healthcare is also worthy of mention, with several EQT-sponsored names such as Cerba and Recipharm featuring heavily. Hot on the heels of Healthcare issuance is Consumer Discretionary, held up by glass repair and replacement company Belron’s dual currency €2,215.4m (equiv.) March issuance. Looking more closely at sponsor portfolio activity in the space, EQT heavily dominates with over €4.5bn (equiv.) of Sustainability Linked Leveraged Loan issuance YTD. Carlyle is also active in the space with over €2bn in issuance (including Nobian’s issuance, co-owned by GIC), and Ardian close behind with €1.9bn in issuance. The key takeaway here then is EQT’s heavy focus on Sustainability Issuance, more than double that of the next most active sponsor (Carlyle).

Whilst pressure on public companies to increase the ambition of ESG initiatives and improve disclosure has been touted as one factor inducing the recent spate of take privates, private equity, although certainly not subject to the disclosure requirements of public markets, has been no stranger to ESG. Debt capital markets have certainly seen their fair share of ESG issuance (as we have tracked), with asset managers across the board are under pressure from their investor clients to greenify portfolios. The most egregious of issuers, operating in traditionally ‘dirty’ industries (such as chemicals, energy, steel, cement and waste) predictably have seen stronger ESG terms (such as Nobian and Beauparc) where as issuers in industries under less of an ESG spotlight (such as Virgin Media-02) can take advantage of slack from investors regarding the ambition of KPIs and SPTs (Sustainability Performance Targets) whilst still happily claiming their greenium.

As has been repeatedly covered in our past monthly wraps, more sizable ratchets and scrutiny of KPI & SPT terms is needed if Sustainability Linked instruments are to represent a material attempt to improve the ESG standing of an issuer. The LMA’s sustainability linked loan principles have been instrumental in providing some basic parameters of what Sustainability Linked instruments should offer, but again significant room for interpretation surrounding the ambition of ratchets and SPT targets hampers the materiality of the ESG terms being marketed.

In the wider market

More broadly, the price of carbon in the EU continues to soar on anticipated increased energy demand for the Autumn, surpassing €60 per tonne from ~€25 per tonne in January 2020 and putting pressure on carbon credit needy issuers such as Raffinerie Heide who have resorted to employing carbon hedging instruments to negate this risk. Climate funds continue their hot streak this year, with TPG’s $5.4bn Rise Climate fund beginning to deploy capital in long-duration battery tech and Nordic Capital raising over €2.1bn (significantly oversubscribed) for its mid-market, ESG focused Evolution Fund - targeting equity investments between €35m-€150m for companies with EVs between €50m-€300m. As is typical for Nordic Capital, the fund will focus on Healthcare, Tech, and Financial Services.

The Big Four also drew headlines in their attempts to join the ESG party, looking to scoop up fees involved in increasing ESG disclosure / the emergence of ESG accounting and a growing demand for sustainability/ESG consulting services.

Selected 9fin ESG Highlights

9fin’s ESG filter has brought to light some important social and governance related news from the previous month which are worth highlighting:

• Belden is facing a class action lawsuit over a November 2020 data breach. The unauthorised access exposed Social Security Numbers, financial account numbers, home addresses, email addresses, and dates of birth

• In the US, the SEC charged former Netflix staffers for insider trading that generated over $3m in total profit

• A full investigation has been launched into Morrisons over ‘cruel’ treatment of chickens at their supplier farms. Campaigners have accused the supermarket chain of hypocrisy over its claims to “take animal welfare seriously”

Kraft Heinz is to face a shareholder lawsuit over knowingly concealing how cost cutting drove away customers and suppliers, making its optimistic statements about its future false and misleading

ESG QuickTakes

As part of 9fin's developing High Yield coverage, we will be producing more detailed ESG analysis for a number of credits. Please let us know your feedback so we can evaluate demand for ESG analysis and any suggested improvements. In August we have published ESG Quick Takes on Waterlogic and Warner Music. If you are not a client but would like samples of our ESG Quick Takes, please email team@9fin.com