Sembcorp should still account for emissions of India coal business even after disposal: Non-profit organisation

HOLDERS of Sembcorp Industries’ sustainability-linked debt should not allow the company to stop accounting for the carbon footprint of its Indian coal power business immediately after a sale, a non-profit climate finance-focused organisation said.

That is to prevent Sembcorp, an energy and urban development company, from claiming and reaping the benefits of hitting emissions targets while providing financing for the buyers of Sembcorp Energy India (SEIL), according to a report by the Anthropocene Fixed Income Institute (AFII) authored by Ulf Erlandsson and Cedric Rimaud.

In response to queries by The Business Times (BT), Sembcorp said there is no ambiguity about its commitments.

“The sale of SEIL underpins Sembcorp’s brown to green transformation strategy and also progresses us towards one of our 2025 targets – the reduction of our greenhouse gas emissions intensity to 0.40 tonnes of carbon dioxide equivalent per megaWatt hour (tCO2e/mWh) from 0.54 tCO2e/mWh in 2020,” Sembcorp said. “Our commitments to our stakeholders, including our bondholders, are very clear and are not subject to interpretation. Every step we take advances us towards the transition of our portfolio, underscoring our conviction to meeting our commitments.”

Sembcorp shareholders on Tuesday (Nov 8) overwhelmingly approved the sale of SEIL to an Oman-led consortium for 117.3 billion Indian rupees (S$2.1 billion) plus interest and adjustments. The deal received approval from shareholders representing 99.95 per cent of shares that voted.

Under the terms of the deal, Sembcorp will provide a facility to the purchasers in the form of a “deferred payment note”. The facility will effectively give the purchasers 15 years, extendable to 24 years, to pay the full sum subject to interest of 1.8 per cent plus the prevailing 10-year Indian government bond yield.

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The interest may be reduced by 9 basis points for every 1 per cent reduction in SEIL’s greenhouse gas emissions intensity against an undisclosed historical base, capped at 180 basis points, or up to a 20 per cent emissions intensity reduction.

Sembcorp’s wholly owned subsidiary, Sembcorp Utilities, will provide technical advisory services to SEIL following the sale, as well as possible corporate guarantees for SEIL’s existing debt facilities, which amounted to about S$2.2 billion with about S$1.8 billion drawn down as at October.

Sembcorp has said a key reason for the sale is to reduce the group’s greenhouse gas emissions intensity, which will fall from 0.51 tCO2e/mWh before the sale to 0.32 tCO2e/mWh. Importantly, that reduction would allow Sembcorp to claim that it has achieved its 2025 target of cutting its emissions intensity to 0.40 tCO2e/mWh ahead of time.

The emissions target is not simply ambition. Hitting that goal before 2025 could allow Sembcorp to avoid paying 25 basis points of additional interest on about S$975 million of sustainability-linked debt. The company also has a S$1.2 billion sustainability-linked revolving credit facility with a similar step-up subject to an additional condition based on renewable energy capacity.

The AFII report disagreed with Sembcorp’s intention to no longer account for SEIL’s emissions following the sale, arguing that Sembcorp would merely be shifting those emissions from operational to financial exposure.

The financing structure could create complications for Sembcorp and its investors, including bondholders, the report said.

First, investors that do not wish to provide liquidity to coal-financing entities may have to deem Sembcorp as a non-bank lender to a coal business.

Second, the purpose of sustainability-linked debt structures is to create improvements in sustainability metrics through financial incentives. If Sembcorp is allowed to deconsolidate SEIL’s emissions to hit its targets, it would enjoy an economic benefit – and its lenders would suffer an economic cost – without any progress in emissions intensity.

Holders of Sembcorp’s sustainability-linked debt should therefore either require that the company continue to recognise SEIL’s emissions as it own until the deferred payment note is fully paid up, or pro-rate deconsolidation as partial repayments of the note come in, AFII said. Alternatively, the company could recalibrate its performance target.

Whether the debtholders can block the deconsolidation of emissions remains to be seen. Sembcorp’s emissions intensity target counts only its direct and biogenic emissions, and indirect emissions from energy usage, but excludes indirect emissions from its business activities and products.

The AFII report said that there should be a discussion about whether SEIL’s emissions after the deal would count as operational or financial exposure for Sembcorp.

International Finance Corp (IFC), which took S$150 million of Sembcorp’s S$675 million 2.66 per cent sustainability-linked bonds due 2032, declined to comment on the SEIL transaction when approached by BT. But IFC, a development institution, noted that its investment was meant “to support Sembcorp in achieving its brown to green transformation strategy commitment”.

“Our agreement with Sembcorp has a defined use of proceeds provision that states that proceeds from IFC’s investment in the sustainability-linked bond shall be used for the financing or refinancing of the company’s renewable energy, or potentially, other sustainable projects in key markets such as India and Vietnam that meet ESG (environmental, social and governance)standards applicable to IFC’s investments,” IFC said.

The issue highlights the challenge of dealing with thermal coal-related assets for companies that currently hold them. Investors and finance institutions around the world – including Singapore’s three major banks – are increasingly excluding thermal coal.

In exchange filings, Sembcorp explained that holding on to SEIL put it at risk of triggering the step-up penalty on its sustainability-linked bonds. The company described exploring the market for SEIL and finding limited options.

Sembcorp “conducted a broad market sounding for a potential sale of SEIL in 2020 and followed up with a targeted market sounding exercise in 2021 with potential bidders to gauge the market’s appetite for a transaction,” the company said. “Bidders were then invited to participate in the current sale process which culminated in the proposed sale.

“Given the limited availability of funding for coal-related projects due to ESG considerations of financial institutions globally, bidders were given the option of vendor financing via a deferred payment note, in addition to the options of using an all-cash bid or a combination of the two.

“Subsequently, multiple binding offers were received, all of which included the utilisation of a deferred payment note. The board reviewed and assessed the binding offers received, and based on a holistic assessment of such offers, the purchaser’s offer was selected.”

Sembcorp shares were trading at S$3.05 as at 3:34 pm on Tuesday, down S$0.06 or 1.9 per cent on the day.