This article is part of NordSIP Insights – ESG Integration Case Book 2020. Read or Download the entire publication here.
According to Saida Eggerstedt, Head of Sustainable Credit at Schroders, green bonds allow investors to improve the behaviour of companies and drive change in a transformative manner. “In the long term, green bonds are credit positive. The issuance of a green bond offers a unique opportunity for investors to deep dive in the company’s overall sustainability priorities and business ethics,” she explains.
“The transparent use of funds requires the participation of the company’s senior management in the supervision of green bond projects, which nudges their culture towards more sustainable practices. Green bonds increase accountability due to improved disclosures, impact reporting, auditing and second party opinions from external agencies.”
Eggerstedt’s choice of case study – the latest green bond from Dutch automobile leasing company LeasePlan – showcases the ability of fixed-income investors to drive decarbonisation, while leveraging her experience as a sustainable fund manager as well as a financial analyst.
Meet the Team
The Schroders Sustainable Credit Europe fund, headed by Eggerstedt, invests in fixed income corporate debt mostly across Europe. “I invest in green bonds because I want to encourage this transition to carbon reduction. My approach is to ask what needs to improve from a sustainable credit perspective,” she says.
Eggerstedt has worked in fund management for a long time and managing sustainable credit funds for the last nine years. “While ESG integration is well underway at Schroders globally- they wanted to recruit someone passionate and experienced to lead sustainable investments in credit markets rather than a traditional fund manager becomes a sustainable credit manager.
Schroders recruited me because they wanted someone that could conduct sustainable investments in credit markets rather than having to train a traditional fund manager to become a sustainable credit manager,” she adds.
“We also have a central sustainability investment team that does topical engagement. The team has experience tackling controversial issuers such as Carnival Cruisers on such topics as modern-day slavery while the credit analysts engage with debut green bond issuers like waste manager Servicios Medio Ambientales. Such committed resources have been useful in engaging with Leasplan,” Eggerstedt explains.
An Obvious Sector Choice
The transportation sector is a prominent sector to greener transition for a sustainable credit investor, according to Eggerstedt. “It is one of the largest carbon-emitting industries, responsible for 20% of CO2 emissions in 2014. Electric vehicles (EVs) are very promising, but as with any type of product that has lower carbon emissions, management commitment and Research and development are key. For car manufacturers, be it Daimler or Ford, the initial investment costs are very high.”
“On the other hand, transportation -encompassing infrastructures like airports, transportation authorities municipalities financing charging stations- was responsible for approximately 40% of all green bonds issued in 2018 the USA according to the Climate Bonds Initiative (CBI),” Eggerstedt continues. “If investments are well-timed, investors can join a company’s journey as it starts shifting from a traditional fossil fuel-based vehicle to EVs.”
The car financings ability to access ECB liquidity is also comforting from a credit perspective. “Following the subprime financial crisis, companies like Leasplan set up banks of their own to access ECB liquidity should a crisis occur,” she adds. “One of the lessons of the 2008 financial crisis is that companies with ongoing short-term financing needs could face a crunch when liquidity dries up. Without access to diverse sources of funding like central bank liquidity, deposits car companies would face the double threat of a recession combined with the inability to refinance themselves.”
An Exclusions-Fuelled Counter-Cyclical Investment
“Our Sustainable Credit fund practices a strict exclusions policy. We focus on core sustainable investors that want to make a change. Among other restrictions, we are not allowed to invest in companies that violated the UN Global Compact,” Eggerstedt says. “As a result, we are unable to invest in Volkswagen, the largest bond issuer in the automotive sector, following their 2015 Diesel scandal when it was revealed that they violated environmental standards and human rights.”
By blocking its access to the leading issuer in the Euro credit market, Schroders’ exclusions policy has revealed opportunities that might otherwise have gone unnoticed. “LeasePlan makes a very compelling investment case,” says Eggerstedt. “It is not as cyclical as one might anticipate and is well diversified with sound regulatory capital. When corporates lack the funds to buy new cars, such as is the case with all the lockdowns at the moment, companies will instead extend their existing leasing and fleet servicing programmes, which is cash-generating for them.”
Moreover, Leaseplan offers leases and related services to large companies as well as SMEs. “I’m always interested in working with companies that serve SMEs because they employ a lot of people which makes them socially important. If someone can lease or sell environmental products such as EVs to an SME, they are also educating those people but busy,” she continues.
Asides from increasingly being a promoter of sustainable transport systems, LeasePlan also has risk advantages over car manufacturers. “Because LeasePlan leases cars to corporations, they don’t incur the direct costs and risks faced by car manufacturers during the energy transition. Despite a likely fall in the residual value of leased cars, the business model is not quite as risky, which is essential in fixed income, where the risk is on the downside.
An Attractive Green Bond Amid Market Stress
The specific investment opportunity that Eggerstedt refers to is Leaseplan’s second green bond worth €500 million, issued on April 3rd, 2020. The security matures on April 9th, 2025, and pays a 3.5% coupon. This transaction was priced at a 99.964 discount to offer 375bps over mid-swaps. The bond was issued under LeasePlan’s 2020 Green Finance Framework, which was reviewed by Sustainalytics. The framework states that eligible projects will focus on battery electric vehicles (BEVs). According to Sustainalytics’s second-party opinion, the framework is “credible and impactful and aligns with the four core components of the Green Bond Principles 2018”.
While initially she had mixed feelings about this new green bond, Eggerstedt eventually came around and bought the bond in her fund. “I was concerned when they announced the new bond at the start of April. We had a massive sell-off in credit markets in March because of COVID19. LeasePlan has enough liquidity, and they confirmed that they have access to diverse sources of funding including securitisation and an internet savings bank.. Still, given the high illiquidity in the markets, secondary bond market spreads widened after they announced their new bond.”
“On the other hand, companies are most eager to engage on the eve of coming to the market. Together with our dedicated financial analyst, I had a conference call with LeasePlan, and we could see they had made quite a bit of progress since issuing their first green bond. From a sustainability point of view, the very fact that they are issuing a second green bond is a positive sign. It means the transition of their clients to the EVs from Diesel and take-up of solutions like charging infrastructure was meaningful and increasing. They told us that 10% of the new cars ordered 4Q 2019 were EVs, with a target of 100% by 2030.”
Valuation remains a key factor in any investment decision, of course. “From a credit market perspective, the new bond was also appealing because it paid a coupon about 200 basis points higher than its predecessor. Even though bund yields have dropped, spreads have widened a lot. The new bond offered a better entry point,” Eggerstedt continues.
Engaging with the UN SDGs
“One thing that is particularly relevant to Schroders’ approach to sustainability is the fact that the green bond framework targets four of the seventeen UN Sustainable Development Goals (SDGs). It can be difficult to show how SDGs are integrated into the investment process. From a sustainable credit perspective, whenever we meet an issuer, we ask them whether they are taking any SDGs into account, and if so, how they measure that,” adds Eggerstedt.
“LeasePlan’s choice of SDGs reveals an environmental concern, as well as a sensitivity to social and demographics factors,” she says. At a time of increased concerns about respiratory problems, Leaseplan’s focus on SDG 3 – Good Health and Welllbeing through low emission mobility and safety– was pertinent. “LeasePlan has also decided to prioritize Industry, Innovation and Infrastructure – SDG9. The EV related services are a clear endorsement of innovation and industry. However, Leaseplan also notes that although the public charging infrastructure has expanded rapidly, the clients also need advice and guidance for all aspect of adoption to greener driving experience. Transitioning to EVs allows the company to promote the technology and drive the expansion of its underlying infrastructure.”
“SDG11, Sustainable Cities and Communities is also on Leaseplan’s target list as they promote sharing and recycling of used autos rather than owning- as well as customized EV solution to clients with diverse needs. Finally, they are also targeting SDG13, Climate Action, and aim to achieve net-zero carbon emissions from its total fleet by 2030 on top of conserving energy at its own operations .”
Addressing Financial and Sustainability Concerns
Having participated in Leaseplan’s inaugural green bond transaction in March 2019, while Head of Corporates, Financials, at Deka Investment, Eggerstedt was familiar with the company, and vice-versa. “I bought their second green bond at Schroders after participating in their first green bond at Deka. We got the first conference call with LeasePlan because they knew we are long-term investors. They had met me before and knew I had very strict questions..”
Based on her expertise, Eggerstedt pursued a two-pronged strategy when she engaged with LeasePlan back in 2019. “Financially, as a BBB-rated company, we thought they could decrease their leverage. Too much leverage is not sustainable in the long run. We took this opportunity to advocate that they retain more of their earnings rather than paying dividends to their shareholders, which would be credit positive in the long term.”
“From a sustainability point of view, I was an early advocate of green bond issuance combined with a commitment to impact reporting and transition to EVs. Together, these measures would enable the company to simultaneously deal with the governance concerns raised by private ownership while addressing climate change.” Eggerstedt is satisfied with the journey so far. “Ideally, I would have pushed them harder to go faster in EV financing and leasing, but their holistic approach to greener transportation options is effective. The results of their sustainability strategy are consistent with their commitments to zero tail emissions by 2030.”
Raising the Bar and Galvanising Laggards
Considering the path ahead, Eggerstedt has a wish list. “I would like all green bond issuers to hold regular webinars rather than exclusively focus on written reports. I want many companies to issue either green or social bonds, and explain how they are becoming more sustainable from a bottom-up as well as from a top-down perspective.”
Eggerstedt also wishes for UN Global Compact violators, like Volkswagen, to work harder and sincerely to come off the list imminently . “As they intend to shift to EVs, it would benefit everyone if they could interact especially with sustainable investors and we could tell them and learn how they credibly improve their governance and also finance their rollout of zero-emission vehicles for the future,” she concludes.
Photo by Andrew Roberts on Unsplash