Sector’s first price-ratcheted ESG bond ‘less susceptible to greenwashing’, says L&Q

The three so-named SPTs the association must hit are as follows:

• SPT 1: Reduce scope 1 and 2 greenhouse gas emissions by 20 per cent by 31 March 2024 vs 2019-20 baseline
• SPT 2: Achieve an average calculated SAP score of 72 or above (low EPC Band C) by 31 March 2024
• SPT 3: Build 8,000 new homes, of which 50 per cent are affordable, by 31 March 2024

The group published its sustainable finance framework in September, which allows it to issue through a range of ESG products, and last week’s issuance marks its first capital markets outing to carry a label.

Asked whether, by implication, there was a risk of greenwashing using a use-of-proceeds ESG approach, Mr Watts said that there was no “right or wrong answer”.

He said: “This sector has made material headway in terms of committing to ESG outcomes – and whether that’s done through a sustainable bond, a green bond, a social bond, be it use of proceeds, or sustainability-linked, there’s a clear intention there.

“We just felt that for this particular issue we want to demonstrate that commitment in the near term, and thus what we are putting on the table here is an economic incentive, whereby if we fail to hit those KPIs, we get charged through the coupon step-up, but reputationally I think that is a big consideration for us.”

He added: “You could argue that doing a green social or sustainable bond is just business as usual for housing associations. Here, we’ve attached these three KPIs that are relevant, core, material and of high significance to L&Q’s current and future operations. They are ambitious and stretching, and that’s exceptionally important, as well. We will have to and are adjusting potential outputs of what we want to achieve to demonstrate our ESG credentials.”

Pricing and penalties

As to the pricing of the bond itself, whether or not gilts+87bps (assuming the targets are hit), is tighter than what could have been achieved on a use of proceeds sustainability bond, is “hard to judge”, Mr Watts says.

However, compared with non-wrapped issuance, he believes the issuance benefited from around a 5bps saving in terms of new issue premium, paying around 2bps compared with about 5-8bps on non-ESG bonds.

At the same time, at 12.5bps the penalty of missing targets would more than reverse this discount after 2024. So, what of the financial risk here, for example if construction sites were to experience another freeze and the 8,000-home target was missed?

Mr Watts calculates that, if targets were missed after 2024, and assuming a new issue premium saving of circa 5bps, the potential cost of the penalty to L&Q in net present value terms would be around £1.1m.

“That £1.1m, if we miss the targets, that could be better used within our business, given our social purpose. But the reality is we’re not setting ourselves up for failure here, we’re setting ourselves up for success. And we’re setting ourselves to align with our commitments, and thus my view [is that] yes of course it’s a risk but it’s a risk whereby we are in control of that risk, and I think that is a very important message.

He added: “On a per annum basis that step-up cost would be £375,000 in cash flow terms. In the context of our overall interest bill, it’s really not that material – it’s probably equal to about 0.2 per cent of our overall interest bill.”

In fact, Mr Watts sees L&Q’s reputation as the greater risk at stake.

“The riskier factor in my opinion is reputationally in the same way that we’ve set out those objectives in our corporate plan – if we don’t hit these, what are the reputational considerations? And that has been balanced into our thinking. And we feel it’s a risk that we’re willing to accept based on the fact that we’re changing behaviour.” 

Launched from L&Q’s £2.5bn European Medium-Term Note (EMTN) programme, established in 2020, the bond was targeted at the group’s particular financing need at the shorter end of the curve.

This included a desire to address refinancing risk in “appropriate buckets”, as well as the 2032 maturity providing “equilibrium in between [L&Q’s existing] 2029 and 2033 maturities”, Mr Watts said.

While, for this tenor of bond, L&Q appears to have set out its stall in favour of the SLB, the maturity of future issuances could be a deciding factor in the kinds of ESG wrapper L&Q adopts.

Mr Watts said: “To role-reverse a little, pulling out SLB KPIs for 20 to 30-year maturities carries with it far more risk, on the basis that unknown events could happen over that time frame, and therefore whilst that’s not impossible, ICMA guidelines state that SLB KPIS must be material and of high significance to us as a business.”

Mr Watts said that in time, he would expect ESG frameworks including L&Q’s to evolve to include science-based targets around sustainability.

“Right here today I do feel it’s more difficult to do the sustainability-linked transaction for a 20 or 30-year maturity and thus today the use of proceeds would be more appropriate for those longer-dated maturities.”

BNP Paribas was sole sustainability structuring advisor on the transaction and joint bookrunner, along with Barclays, HSBC (B&D) and National Australia Bank (NAB). Rothschild & Co acted as financial advisors to L&Q, Devonshires Solicitors as legal counsel and CBRE as valuers. Allen & Overy acted as legal counsel to the joint bookrunners.

Investor interest saw the book 2.5 times oversubscribed at peak, with L&Q choosing to increase the issuance by £50m from the initial benchmark, to £300m.

Commenting at the time of the bond announcement, Waqar Ahmed, group director of finance at L&Q, said: “We are thrilled with the successful placement of this landmark sustainability-linked bond, which is a first for our sector. It will allow us to meet our stated objectives and further strengthen our liquidity position, while stretching us to achieve environmental and social targets that greatly benefit our residents and the wider community.

Agnes Gourc, head of sustainable capital markets at BNP Paribas, said: “L&Q is proving that finance can be used to align social and environmental targets and drive real progress in a transparent, measurable way. L&Q’s communities benefit from new and affordable homes constructed with a lower environmental impact, and investors get a direct link between their investments and the SLB commitments.”

Mr Watts added: “I think we’ve landed here a very good transaction not only for us but for the wider sector. For others, particularly the bigger players in our sector who are firmly established in the debt capital markets and have got frameworks and programmes, it may provoke [them] to think about whether SLBs are an appropriate route to financing.”