Going green can be hard work
Green bonds have hardly penetrated the manufacturing sector, partly because making companies’ operations sustainable is not easy. Any green bonds they issue will be similarly complex. As Koninklijke Philips’s debut showed, this asks a lot of the issuer — and the investors. Jon Hay reports
Sustainability is not just for the few. All parts of the economy will have to become more energy-efficient, recycle their waste and cut greenhouse gas emissions, ultimately to zero. But so far, green and sustainable bonds remain, in the corporate sector, a niche enthusiasm.
Eighty-four percent of the $219bn of corporate socially responsible investment bonds ever issued have come from just four sectors, according to Dealogic: utilities and energy, transport, property and construction.
That leaves 22 other sectors having produced an average of just five deals each, totalling $1.3bn. This concentration is frustrating for green bond investors, which struggle to build properly diversified portfolios.
When a new issuer from an unusual sector joins the market — as Philips did in May 2019 with a €750m deal, its debut Green Innovation bond — SRI bond specialists rejoice, hoping more will be inspired to follow.
“Investors automatically consider renewable energy producers as green, whereas for a health technology company like Philips this may not yet be immediately evident to the outside world. So it’s arguable that for us it’s more difficult than for them,” says Ignacio Mosquera, group treasurer at Philips in Amsterdam.
That is certainly true. How Philips has to define green and sustainable spending is more complex than for some other issuers — and not every investor was won over. But the bond’s reception suggests it was worthwhile.
The electronics company has focused increasingly on healthcare, producing diagnostic, treatment and monitoring devices — though it still makes TVs and shavers.
Few manufacturers have found it easy, or useful, to issue SRI bonds. In the three high tech manufacturing sectors that have issued most — electronics, machinery and consumer products — giant issuers Microsoft, IBM, Oracle, Siemens and John Deere have not touched them. Of the top 50, only two have — Apple and Unilever.
This is perfectly rational. Their sustainable initiatives are not often big and chunky, but myriad small efficiencies. Cataloguing and auditing all those for investors’ benefit is a hassle. They can issue a bond any day. A green bond might save them a few basis points, but so what?
Philips did not rush in, despite having long pursued sustainability. In 2016, it set out by 2020 to make its operations carbon neutral; grow its “green” revenues to 70% of sales; and make 15% of revenue from “circular economy-driven propositions”.
Like the €1bn loan it signed in April 2017, with pricing linked to its ESG rating from Sustainalytics, the bond was intended to signal the thoroughness of this commitment to the market.
“We’ve done the deal because we advance sustainability in all areas of our business, including treasury, and issuing this inaugural Green Innovation Bond is a good example of that ,” says Mosquera. “We strive to make the world healthier and more sustainable through innovation. We thought doing a Green Innovation bond was the right way to follow that strategy.”
Philips’s bond Framework allows it to issue Green Innovation Bonds and Sustainability Innovation Bonds. The latter would concern tools to improve experiences for patients and lower healthcare costs; and products to reach communities with poor health.
Green bonds, like the one Philips issued in May, are used for three kinds of spending, each with several sub-categories. The first is green research and development to make products cleaner and more efficient. Mosquera points to a new MRI scanner, which uses only 7 litres of liquid helium for cooling, instead of the usual 1,500.
Philips spent €230m on green R&D in 2018, out of its €1.8bn R&D budget.
The second strand is spending on ‘circular’ recycled products.
Finally, proceeds can be used for energy, water and waste efficiency in Philips’s operations. Its factory in Pune, India, will run on solar power.
One big green bond investor passed on the deal, over doubts about the process for selecting projects and the large component of operating expenditure, rather than capital projects.
Mosquera says project selection has been assessed by Sustainalytics as part of its second opinion, and that EY will audit the allocation of proceeds.
Philips can allocate proceeds to past spending, but intends only to use future outlays. This makes it difficult to predict shares of capex and opex.
The bond required deeper analysis. But many made the effort.
Led by BNP Paribas, HSBC, ING, MUFG and Rabobank, the Baa1/BBB+/A- rated seven year deal pulled in a €3.3bn book at the initial price thoughts of 65bp-70bp over mid-swaps. That enabled the spread to be cut to 42bp — only 0bp or 1bp of new issue premium. Like other deals around the same time from Vesteda, Tennet and Vodafone, it showed how green notes can price very tightly. About 45% of the investors were new to Philips. For those that took the time to digest the Framework, the bond achieved its aim. It showed how sustainable thinking can penetrate a company — and must, if it is to become genuinely green.