March 2019

SGV thought leadership on pressing issues faced by chief executives in today’s economic landscape. Articles are published every Monday in the Economy section of the BusinessWorld newspaper.
25 March 2019 Christian G. Lauron and Abner E. Serania

A New Green Revolution: The Green Bonds Part 2

(Second of two parts) In the first part of this article, we discussed some of the environmental consequences brought on by the rapid increase of infrastructure and economic development in the country. Although the Philippines maintains the lowest ecological footprint in ASEAN, growing overconsumption, unregulated production, and waste mismanagement all contribute to the environmental burden on the land. One method to increase the impact of environmental protection and sustainability involves grassroots efforts not just from private citizens, but from organizations, local communities, and Local Government Units (LGUs). Although there is a lack of funding on this front, the Department of Finance (DoF) has begun urging its Bureau of Local Government Finance to strengthening LGU fiscal autonomy. To be discussed further are the use of green bonds as an alternative funding source, which can encourage self-reliance and project autonomy, how green bonds are structured, and how they can be adopted for local implementation. Like conventional bonds, green bond prices are also driven by interest rates, credit risk, foreign exchange markets, market perceptions of liquidity, and supply and demand. As interest rates increase, bond prices decrease. Moreover, the required return for investors tends to increase as the credit risk assessed to the issuer increases. Also affecting bond pricing are the anticipation of the project’s success and backup plans for future business opportunities. All of these are taken into consideration in calculating bond return. Slightly deviating from a conventional bond, other additional terms and characteristics of a green bond — whether it is a floating rate, cancellable or callable — also affect its price. Further studies from Harvard Business School show that most US municipal green bonds are issued at a premium, where after-tax yields are six basis points lower than a conventional municipal bond. It makes sense to encourage more investors to invest, although most green bonds are generally oversubscribed. Since the first green bond issuance in 2007, investments in green bonds have increased in recent years, with the International Finance Corp. (IFC) a unit of the World Bank Group, reporting an annual additional $1-trillion investment. While the creation of the green bond seems to follow conventional bond creation, evolving guidelines have been published across different markets around the globe to guide the creation and issuance of these bonds. It also provides a clear distinction for green bonds since investors demand identification. Under the Climate Bonds Initiative, a four-stage bond certification process needs to be passed: project identification, bond structuring, transparency on use of proceeds, and screening of credentials. Furthermore, the International Capital Market Association has issued green bond principles aimed at streamlining voluntary guidelines in creating and issuing a ‘credible’ green bond. In the Philippines, the Securities and Exchange Commission (SEC) has adopted guidelines from the ASEAN Green Bond Standards (AGBS) to improve an awareness and appetite in capital funding for green projects in the ASEAN region. It outlines rules and procedures for issuing ASEAN Green Bonds in the country starting with: – The identification of eligible green projects, excluding fossil fuel power generation from the list; – Clear documentation of the utilization of proceeds; and – Proper establishment and disclosure of project selection and evaluation. Management of proceeds must also be disclosed, where net proceeds must be tracked and adjusted periodically to match allocations required. Lastly, there should be an annual report on the projects done with their corresponding resource allocation. APPETITE FOR GREEN BONDS In the Philippines, the first green bond was issued in 2016 by Aboitiz Power Corp. Banco de Oro Unibank followed in December 2017. In 2018, a locally denominated green bond emerged through the $90-million loan issued by the IFC for Energy Development Corp.’s (EDC) geothermal energy generation output. This is just a piece of the $30-billion funding requirement for the energy sector in the Philippines. Both public and private sectors have already begun gently nudging investors and issuers towards the green bonds market, as can be observed with the SEC’s recent adaptation of the AGBS, and the 2018 Philippine Investment Forum’s discourse on the future of green bonds. However, though the returns are fairly comparable to that of a conventional bond, issuers hesitate at the cost of additional requirements of the “green” label. Thus, where investors seek to ensure they invest in truly green projects, issuers look at it as a burden to consider. In the Philippines where the preliminary and strongest of impacts of climate change can be felt through intensifying typhoons and unusual flooding brought by rising sea levels, green bonds can be a way for the national government and the LGUs to raise funding for climate change mitigation and resiliency projects through proper waste management, waste-to-energy, and resilient infrastructure initiatives. This is the case in the US where municipal bonds were expected to increase to $15 billion in 2018, up 43% from 2017 based on S&P Global Ratings report. Given that the country requires much financing for its programs, green bonds can potentially tap into the $36-trillion market. After the SEC adopted AGBS, green bonds are now being seen as potential investment vehicles that can ease the flow of funds between needing LGUs and willing investors. They may be viewed as alternatives to the typical fund-raising avenues of the LGUs such as loan applications to Government Financial Institutions that are backed by their respective Internal Revenue Allotments to augment their income. Given that such bond issuances have additional (and more tedious) requirements, the national government must also be able to extend technical assistance to such LGUs willing to explore this fund-raising track, through the BLGF. Strides can be taken to foster widespread awareness of the key role green bonds can play in securing the sustainable development in support of the country’s economic and social growth. However, as in all worthwhile initiatives, it will require close and intense collaboration among the government, the private sector, and the country’s banking and capital markets. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Christian G. Lauron is a Partner and Abner E. Serania is a Senior Associate of SGV & Co., respectively.

Read More
19 March 2019 Hemant M. Nandanpawar and Arielle Nicole R. Papa

A New Green Revolution: Green Bonds Part 1

(First of two parts) The Philippines’ GDP growth has maintained a relatively stable upward trend over the last decade. Regionally, the archipelago continues to outpace most of its neighbors, maintaining an average annual growth rate of six to seven percent in the last seven years. The driving force behind this economic and developmental progress is the reinvigoration of the national government’s investment in public works, health and education infrastructure, and improved public financial management. However, the effort and resources expended towards the modernization and overall development of the Philippines still falls short in one key consideration — climate and environmental resilience and the sustainability of these infrastructural pursuits, and of the overall development and growth path of the country in its entirety. Post-liberation, the Philippines has followed traditional development pathways that — while conducive to basic economic objectives of expansion and growth — are inherently unsustainable to the landscape and the environment. As of 2018, the manufacturing sector has contributed over a quarter of all value generated within the economy. Partnered with the increased activity in infrastructure development, and the resulting rising demand in land, resources, and energy, the economic activity of the country continues to exacerbate the environmental burden of sustaining day-to-day operations. Despite maintaining the lowest ecological footprint among its neighbors in Southeast Asia, the rapidly-growing incidence of overconsumption, unregulated production, and lack of a solid waste management framework have significantly amplified the population’s strain on the country’s natural carrying capacity. Since the 1960s, the country’s resource demand has more than doubled, and the resulting Greenhouse Gas (GHG) emissions have grown by a whopping 67% since 2007. Waste management remains another critical shortcoming. As of 2015, the Philippines has become the third-largest source of plastic pollution, directly affecting the rapid degradation of local marine life. A more direct and dire consequence of waste management malpractice is experienced during typhoon season, where major flooding across cities becomes a common and unfortunate occurrence. Linked to that are several other issues in energy, transportation, resilience, agriculture, and overall social and environmental welfare. Although bleak, it is certainly not too late to turn the tide against this lack of environmental awareness and integration. A hopeful study carried out by the United States Agency for International Development (USAID) shows that despite the rapid growth in GHG emissions, emission levels were just over a third of GDP growth for the same period, indicating the potential for notable improvements in the future. The responsibility of this environmental and climate change rehabilitation will need to fall on the collective shoulders of the public sector, private corporations, and most importantly, the citizens themselves. On that note, the most impactful and sustainable approach to environmental protection, climate change mitigation, and adaptation, often begins at the grassroots level — within organizations, localized communities, and even at the Local Government Unit (LGU) level. The bottom-up approach starts off simple, but it ultimately allows the target beneficiaries to create sustainable solutions that are tailored to their particular needs and context. The lack of financing, however, limits the potential for green growth and development. As an example, financing for LGU-led projects is sourced predominantly from government Internal Revenue Allotments (IRAs), which, depending on the size of its municipalities, make up 50-70% of their respective budgets. In response, the Department of Finance has been urging the Bureau of Local Government Finance to take more steps in strengthening LGU fiscal autonomy. At the moment, the push directing Public-Private Partnership and Overseas Development Assistance financing towards local governments has significantly increased funding pipelines for LGU-initiated projects. There is an opportunity to further accelerate this through the use of green bonds as an alternative funding source, which in turn can foster self-reliance and project autonomy. Through this, the investment can empower the community to learn, do, and offer more, leading to great growth potential. Within the private sector, green bonds may help incentivize the correction of negative environmental externalities within established operations, such as in energy efficiency improvements, pollution controls, and energy mix diversification. As most of these pursuits emphasize impact over profit, traction for their growth has been weak, in spite of the obvious benefits and pressing need for active action in striving for green infrastructure. In the second part of this article, the discussion will delve towards the structuring of green bonds as well as further opportunities for local adoption. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Hemant M. Nandanpawar is a Senior Director and Arielle Nicole R. Papa is an Associate of SGV & Co., respectively.

Read More
11 March 2019 Katrina F. Francisco

How non-financial reports can tell your value creation story

Of late, a number of companies in the Philippines have been releasing non-financial reports, either called “Environmental, Social and Governance (ESG) Reports,” or “Integrated Reports,” or “Sustainability Reports.” However, these are not yet mandatory. In fact, it was just recently that the Securities and Exchange Commission (SEC) released Memorandum Circular No. 4, which provides the sustainability reporting guidelines for publicly-listed companies on a “comply or explain” approach for the first three years of implementation, starting with the 2019 reporting period. In the absence of a reporting requirement, a key driver that has influenced companies to disclose non-financial information has been the demand from their investors for such reports. In the past four years, EY Global has been commissioning the Institutional Investor’s Custom Research Lab to conduct surveys with institutional investors around the world, to assess if non-financial information plays a role in their decision-making. According to the 2018 EY Global Climate Change and Sustainability Services study, “Does your non-financial reporting tell your value creation story?,” ESG information is now considered an essential criterion for investor decision-making. Investors have come to understand the significant link between ESG factors and a company’s performance and long-term value. INCREASING RELIANCE ON ESG A high of 97% among the investors surveyed in 2018 said that they evaluate, whether formally or informally, the non-financial disclosures of target companies. Risks related to governance, supply chain, human rights, and climate change are some of the main ESG factors that they look into. In the previous year’s report, only 78% undertook reviews of non-financial disclosures. The dramatic increase is mainly a result of widely-known scandals related to poor corporate governance, more data showing the impact of climate change on business, and an increasing awareness of the social impact of business. DEMAND FOR MORE CONSISTENT DATA The quality and relevance of disclosed non-financial data vary considerably by company, industry, and region, with 56% saying that the disclosures are either lacking or not available for any meaningful comparison to take place. Investors now want to see more comparable data at specific points in time, as well as over a period of time, which allows them to evaluate progress within a company and identify the leaders and laggards within an industry. In addition, investors note that there are extensive disclosures relating to governance policies and practices, yet they often overlook discussions on accountability in relation to non-financial information. Investors want to see not just the current practices, but also management effectiveness on these non-financial metrics over a short, medium and long-term basis. IMPROVING THE RATE OF DISCLOSURE Investors agree that ESG disclosures have improved significantly over the years, especially in the area of governance, which is largely driven by exchange-listing or accounting requirements. Additionally, investors perceived that 82% of the companies they do invest in are actually able to assess materiality of governance factors properly. However, only 64% of the companies they invested in actually assessed social factors properly, and only 11% of these companies properly assessed environmental factors. The surveys indicate positive growth in the area of ESG disclosures, although the numbers also show that the concept of materiality in relation to ESG factors and sustainability still has a long way to go before majority of them comprehend and integrate them into their business practices. CONCERN OVER PHYSICAL CLIMATE RISK Given that the risk from climate change is one of the main factors investors scrutinize, a majority (around 70%) indicated that they will closely evaluate disclosures relating to the physical risks of climate change in their investment decisions and allocations over the next two years. Without disregarding transition risks, 47% of the investors said that they will also consider these risks of adjusting to new regulations, practices, and processes. Investors are apparently keen on how board members and senior management intend to exercise oversight around these risks, especially if they are material to the business. NEED FOR INVESTMENT-GRADE ACCOUNTING STANDARDS AND COLLABORATION Of the survey’s respondents, 59% of investors saw the need for more prescriptive accounting standards for non-financial information. The investors recognize that since they are not experts in every industry, they need to adapt and try to establish the material factors for each industry with focus on those that mitigate risks and create value for business. However, quantifying those risks and translating them into financial terms can be challenging. This is why investors believe it is critical to develop a common standard that has enough flexibility to allow companies to report what is material to them and their respective industries. This way, they will be able to compare, establish benchmarks and spot trends relevant for their decision-making. Investors are confident that this can be realized when there is greater collaboration among regulators, trade groups, NGOs and even among themselves. The collaborative effort will assist investors in defining what are most substantial to a company’s long-term sustainable growth. NEXT STEPS The report recommends four key areas that companies should consider to effectively articulate what investors are looking for. First, establish a structured materiality analysis process that allows companies to: * Set strategic objectives and overall corporate strategy; * Define the issues that will be covered in disclosures and reporting; * Design Key Performance Indicators (KPIs) to enable measurement of performance; and, * Align ESG risks with the risks managed and prioritized by business for a more cohesive sustainability risk management. Second, since the materiality process allows companies to see where the largest impact can be made, appropriate methods to measure and report the social and environmental outcomes should be properly identified. Third, identify the KPIs that would translate risks and outcomes into financial proxies for investors to assess the risks and long-term value creation process of the companies. Last, continue to engage with investors and other stakeholders and report more comprehensively on material non-financial information for a better understanding of how they are creating long-term value. With the increasing global focus on environmental issues and corporate social responsibility, and now additional compliance pressure from SEC MC No. 4, Philippine companies with robust ESG reporting policies may find themselves reaping more significant long-term economic, social and reputational benefits. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Katrina F. Francisco is a Senior Director for Climate Change and Sustainability Services (CCaSS) under Assurance (Service Line) at SGV & Co

Read More
04 March 2019 Josef Pilger and Christian Lauron

Revitalizing retirement, pensions and social security Part 2

(Second of two parts) If we evolve our thinking about social security, pension, retirement and voluntary savings, could we deliver better socioeconomic outcomes for the Philippines and improve the financial well-being of millions of Filipinos? In the first part of this article, we discussed the existing social security, pension, retirement, and voluntary savings mechanisms in the Philippines. While these already provide great benefits to many Filipinos, these systems can still evolve to become more modern and efficient. By revisiting our social security and pension frameworks, they hold the potential to grow into powerful savings and economic engines which can proactively support the development of our national economy. We also discussed the nine key, systemic dimensions that were identified in EY’s global framework for social security, pension, retirement and voluntary savings. PUBLIC AND PRIVATE SECTOR COLLABORATION CAN LEAD TO BETTER OUTCOMES Many countries increasingly leverage the experience and capabilities of domestic and global financial services organizations to accelerate the evolution and growth of national savings pools. In the key anchor “faster, better, and cheaper,” outcomes and delivery are often applied to those products and services that the government considers less as core tasks, relegating them to enablement. Employment-based and customer-based voluntary pension, retirement, and savings systems are often delivered by financial services providers in the private sector. But the government’s interest is in the outcomes and conduct of those solutions. They must encourage concurrent development of contextual parameters to ensure that sustainable, predictable values are delivered. Community expectations are high. The government must ensure that the joint delivery of such values is in the best interest of the customers and the overall public. Some possible areas where private financial service providers could add value: financial inclusion; financial literacy and advice; digital customer and employer retirement platforms; data and payment enablement; investment, life insurance and other similar products and services; operating broader financial well-being ecosystems; and providing access to leading practices, solutions and capabilities supported by relevant experiences in both local and global markets. Naturally, there are also certain contextual elements that must be established to deliver sustainable value. Examples of this are robust management and governance systems that can handle possible conflicts of interest; meaningful deterrents for poor behavior and outcomes; clearly defined roles with effective monitoring and scrutiny protocols; appropriate incentives that are aligned with reasonable compensation; and a deep and mutual long-term commitment to service. The collective, direct benefits from evolving and expanding social security, pension, retirement, and voluntary savings solutions will be significant for all stakeholders. The indirect benefits from a deeper and broader capital market can enable the funding of more extensive and long-term infrastructures in the country. However, the transformation process will require effort and three very important steps: 1. A thorough understanding of the current situation; 2. A comprehensive analysis of options and their qualitative and quantitative socioeconomic stakeholder impact to determine the desired next evolution stage; and 3. An implementation road map that systematically converts policy aspirations into member and economic outcomes. To help us better understand what is needed to evolve our current systems, we should consider some relevant questions, such as: 1. What social contract do Filipinos expect from the government? What are the strategic objectives of our social security, pension, retirement, and voluntary savings systems? What are our measures of success to expand public confidence? How do we measure up today against delivering the objectives? 2. What are the roles of the existing providers and solutions against the strategic objectives? And what oversight, governance, regulatory, and accountability frameworks and mechanisms do we need to effectively align and ensure each piece delivers against short and long-term expectations? 3. How do we systematically expand inclusion and participation in the existing solutions? What additional and refined solutions do we need to achieve our strategic objectives? 4. What are the short and long-term costs, benefits, and risks for the government and the ordinary Filipino citizen to evolve the current state of the country’s social security, pension, retirement, and voluntary savings systems? What are the risks of doing nothing? 5. How could we further improve efficiency and effectiveness of existing providers and solutions? How can we explore collaboration and shared services solutions to future-proof delivery, while enhancing member and employer outcomes and experiences? 6. What would a sustainable plan to gradually close the funding gap of the three, existing government-based solutions to ensure fiscal budget predictability, and long-term financial system sustainability look like? 7. Would the existing systems and mechanisms and their members benefit from Shariah-compliant products? How would we design and implement such products? These are just some of the initial questions we need to raise, and ultimately address, for our pension mechanisms to grow even more fruitful for the benefit of hardworking Filipinos. Regardless of status and sector, the primary goal of every citizen is to create a prosperous life. The conversation must continue on this front by asking more questions, and raising potential solutions in other related subjects. There is some interest in areas concerning private pensions, as envisaged by PERA (Personal Equity Retirement Account), the rise of digital and micro pensions, the convergence of advice and wealth and pension, and the role of pensions in infrastructure investments. Encouraging collaboration between the public and private sectors may eventually result in productive solutions that can address these and other questions. It is envisioned that a partnership between government and private industry will spur dialogue for a more detailed and developed framework on our existing saving mechanisms. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the authors and do not necessarily represent the views of SGV & Co. Josef Pilger is EY’s Global Pension and Retirement Leader. Christian Lauron is an Advisory Partner from SGV’s Financial Services and Government and Public Sectors.

Read More
Leading the way in business

Other SGV News and Publications