The UK Municipal Bonds Agency has moved a step closer to an inaugural ESG transaction after a draft reference ESG bond framework was approved, with the institution targeting a launch in the first half of 2021.
“As we have been talking to local authorities, there has been some clear interest and support behind ESG issuance," June Matte, managing director at PFM, the UK MBA’s managed service provider, told IFR.
“Many of them have green initiatives and targets they are working towards so there has been some support regarding getting credit for these green projects. As we got more into it, it made more sense for the agency, given who its constituency is, to look at a wider ESG framework which is green, social and sustainable.”
The framework is aligned with ICMA principles, which also allows for the classification to be applied, for example, to refinancing existing projects.
“One of the things we find attractive around this is that under ICMA frameworks, which we have adopted, is that we can look three years back and two years forward," said Matte.
"So it does give local authorities the ability to go back and say have we spent money that we could now reimburse ourselves for, for projects where the proceeds have been spent and we can show that they would qualify. That would provide a refinancing opportunity that is cost effective.”
Several authorities have already shown an interest in using the framework, according to Matte.
“We’re talking to three different entities who fit the bill, so it’s a question of who gets over the finish line first. Needless to say, there is a lot of interest because a benchmark size deal that has the name of a single council, or a group of councils, makes a significant political statement about their commitment to both green and social."
The announcement is another example of the further dissemination of ESG issuance, as an increasing number of issuers look into adopting the format.
“It highlights the trend of what I call ESG going local," said Arthur Krebbers, head of sustainable finance, corporates at Natwest Markets.
"This whole agenda in the capital markets that began with multinational organisations and supranational bodies is now moving to much more local entities, including those in the public sector. There’s now significant interest across municipalities, higher education and housing associations."
New angle
After six years of false starts and delays, the issuer finally made its debut last March with a £350m five-year on behalf of Lancashire County Council which was followed up with a £250m 40-year in August.
However, a third deal, this time on behalf of Warrington Borough Council, was scuppered after the Public Works Loan Board announced a 100bp cut in late November.
“I don’t think that much has changed in terms of the fundamentals of the UK MBA," said a banker.
"The success of the Lancs trades indicates what was possible, short-end/long-end, able to identify savings, able to identify investor demand, good feedback all round."
The issuer's main goal at creation was to offer benchmark deals for multiple councils at the same time, implementing a system of cross guarantees which would allow councils to band together and attain favourable financing conditions.
While this has yet to transpire, the ESG angle fits neatly with the broader approach as local authorities often lack the expertise and resources needed to gain the appropriate accreditation.
“We think if we can make it as easy as possible for local authorities to participate it should be a win-win for everyone," said Matte.
“What we are trying to do is to create a programme which is user friendly so the certification work that is required by institutional investors, to have a third party come in and bless the framework, we will undertake that at the agency level. The record keeping and annual reporting that is also required by investors will also be done at the agency level."
For local authorities, much of what they already do is ESG in nature, but without a framework any funding cannot be classified as such.
“Virtually everything short of commercial property that local government funds, is either green or social," said Matte. "It’s housing, it’s infrastructure, it’s transport, all those things.”
Improved pricing?
One potential benefit of pursuing ESG issuance is the attraction of improved pricing levels, which given the PWLB cut could be of even greater significance.
“Because there is such a shortage of ESG paper, there’s a pricing advantage which can be in the range of 5 basis points," said Matte.
"So we can offer additional benefit to local government if they can indeed certify their projects as being ESG. I think there’s some attraction to be able to do that, to say our authority is committed to this and then to have a pricing advantage, that’s just the icing on the cake."
Given the natural alignment between local authorities' projects and ESG, as well as the possibility to improve on pricing, the decision to pursue the framework makes a lot of sense, according to the banker.
“If you’re going to try and shave basis points in this current market, it’s a great angle to take and it’s also a fairly obvious angle to take," he said.
“While it might not make a massive difference to these spreads, in terms of the incremental interest it will help around the fringe. It will create a bit of momentum around the UK MBA project around the time there’s talk of a green Gilt and they can probably use some of that momentum to help themselves later on this year.”