Alongside commitments to net-zero greenhouse gas emissions, healthcare and life sciences companies are also moving to address the wider range of targets outlined in the United Nation’s Sustainable Development Goals. And, as the volume of funds with socially responsible investment themes increase, the healthcare sector is looking to sustainable finance as a way to fund their part in the transition to a ‘just’ and carbon free future.
HMi caught up with Jacob Michaelsen, head of sustainable finance advisory at Nordea Bank, to discuss the development of the sustainable finance market and its relevance to the healthcare sector.
The following transcript of HMi’s interview with Jacob Michaelsen has been edited for brevity and clarity.
HMi Just as in the rest of the financial markets, we’ve seen green bank lending and bonds appear in the healthcare sector. But now we’re starting to see more in the way of sustainability-linked deals. Could you explain the difference between the two products and why we’re seeing more sustainability-linked issuance coming to the market?
Jacob Michaelsen Yes. But first a bit of background.
As you said, Environmental Social and Governance (ESG) debt is a feature in more than just healthcare. We’ve been on close to a 15-year run with the product now, with the first green bond coming out in 2007. So, we’re not talking about a nascent market on the green side anymore, but it’s much newer on the sustainability side – particularly with sustainability-linked structures.
With green or sustainability bonds, proceeds are earmarked for a specific green or sustainability project only. With sustainability-linked structures, there are no specific projects against which money is invested, lenders are interested in the overall performance of the business itself from a green or sustainability perspective measured against relevant Key Performance Indicators (KPIs).
Sustainability-linked structures developed in the bank lending market more recently in reaction to the limited availability of green assets in which companies can invest.
The structure is more inclusive as it’s not project specific but is aligned with the overall company performance. From the loan market, sustainability-linked structures quickly migrated into bonds.
HMi Have sustainability-linked structures, with step-up or step-down features on the interest rate paid by borrowers, reached a level of standardisation?
JM The structure was first applied in the loan markets where there are very well-developed concepts of margin brackets and where step ups in the margin paid by borrowers are based on targets linked to targets such as leverage ratios. So, it made perfect sense to flip the structure to include a sustainability target – the KPIs.
After a while, we found that investors in the bond market would accept these same coupon step-up structures. The relationship between bond investors and borrowers is different from that in the loan market, however, so we must recognise that we are still in the early days of the sustainability-linked bond market, and we still need to thrash out a few nuances before we can really start to talk about more fully harmonised standards to the structures. But it’s getting there, which is really exciting.
HMi What’s in it for the borrower?
JM The market is still trying to find its feet, but borrowers recognise that there’s something interesting there for them as they can reduce their cost of funds. But it’s not just a walk in the park, because they still need to have a good sustainability strategy underlying all of this effort.
You need to identify KPIs that are of sufficiently good enough quality, and then set targets that are ambitious. It’s not just a box ticking exercise.
Nevertheless, it’s still a bit more manageable for treasury teams because, unlike in ‘use of proceeds’ financing, such as with green bonds, you are not encumbered by addressing sustainability in physical assets.
With a use of proceeds structure, the amount you can raise from ESG instruments is constrained by a limited availability of assets.
Sustainability linked structures are much more exciting as you have flexibility. It doesn’t matter if you borrow US$100m or US$1bn with sustainability-linked notes, it just provides much more flexibility for the treasurer to work with.
It is still a relatively new market, however. Use of proceeds green bonds still have greater credibility as the market for these structures is not only much older, but also because your investment is spent on specific green assets.
With sustainability-linked notes (SLN) investors don’t have that same certainty. Money could be spent on something that isn’t necessarily green in nature, it’s more that the company is promising to make progress on certain KPIs. They are different instruments and investors are still getting up to speed with the concept, yet they do appreciate sustainability bonds over normal bonds.
We’ve seen a lot of interest in the sustainability bond market, in particular from non-traditional green bond issuers – specifically, unrated or lower-rated companies or private companies, or companies that do not have enough suitable assets to justify a use of proceeds bond.
That’s the backdrop for this market’s development, and it’s also the reason sustainability-linked structures are so relevant for a lot of healthcare companies where it is a bit difficult to talk about green agendas.
Reducing CO2 emissions is not a key feature for most parts of the healthcare sector, there’s more of a social angle. But even that is not straightforward, which means deals linked to KPIs are much more relevant in this sector. You can still have green KPIs, but CO2 reductions might represent just one of the overall targets.
HMi What kind of KPIs are you seeing in the healthcare sector?
JM It depends. It’s important to recognise what is relevant to each company, and then whether targets are ambitious.
More and more companies have materiality assessments, and they will be able to give you a nuanced perspective on what is relevant for them. The challenge is that as well as choosing something material to target, you must also be able to define it, manage it and monitor it. That’s what will make them meaningful.
It’s not just a case of choosing from a long list of possible KPIs, it’s about a discussion between borrower and lender as to which ones are most relevant. We still tend to see CO2 emission reduction targets coming in at the top of the list of KPIs, as that is the most understandable, manageable and measurable, but gender diversity is also a popular target, as well as ‘health and safety’.
In healthcare specifically, targets could relate to something that has a direct social value. It could be patient outreach, or taking a specific initiative, or making specific investments to reach more potential patients in, for instance, rural areas that don’t normally have access to certain types of medicines.
That’s clearly a positive action and something we want to encourage. Something that is material and something worth incentivising.
HMi Healthcare seems a natural sector for sustainable financing due to the social aspect to the business. Does ESG financing only apply to companies doing more than ‘business as usual’?
JM I think it’s more of a question of nuances: when is something considered to be business as usual and when is it a bit more?
It’s an interesting question because some companies are doing good stuff as part of normal business.
It comes back to a subjective view. Are targets material, meaningful and are they ambitious.
The reason we tend to latch on to CO2 emissions is because they are recognised as being material, and we’re able to identify whether targets are ambitious because we have science-based targets, and we know we need to get to net zero. But if you’re talking about biodiversity then, first, how do you measure it? What’s the metric?
The challenge we have is that outside of CO2 emissions, it’s extremely hard to produce consistently good KPIs and targets. So it’s very much decided on a case-by-case basis.
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