Special Report ESG: Carbon Risk, Yielding results
Last year was by far the most successful on record for green bonds, with $36.6bn (€31.2bn) in debt issued. Driven largely, but not entirely, by national and multi-national development banks, issuance increased more than threefold from 2013’s $11bn total, but the number and volume of corporates involved now offers investors a range of possibilities if they wish to invest in a way that is carbon and climate-conscious.
The increased activity in the market has seen the matter become mainstream, with large investment houses now showing an interest in the field. But institutional investors concede that work is needed to guarantee the development of a sufficiently deep and liquid market, leading to calls from asset owners worth $2.2trn (€1.9trn)for governments to kick-start the market by offering guarantees and tax incentives.
Sweden’s AP funds are advocates of green bonds and were signatories to the letter from December that called for “clear and independent” industry standards. The problem remains as to what constitutes a green, or climate bond.
Despite the recent activity at European level to create a Capital Markets Union, and the potential this presents for the European Commission to grow the market through continent-wide standards, François Passant, executive director of Eurosif thinks voluntary codes are preferable.
“While standardisation is very much welcome and needed with regards to green or climate bonds, our view is that the market should take the lead, at least at this stage, in producing ‘soft regulation’,” he says. “At some point, however, if the market is not in a position to come up with unified standards that meet the needs of investors, then there might be the case to add legislative action but this is, in our view, far too early at this stage.”
The move towards voluntary standards has led to the launch of the Climate Bond Initiative, which should eventually help investors avoid falling foul of products that are essentially ‘greenwashing’.
The initiative’s suggestion has been, at least in the area of property green bonds, that only buildings at the leading edge of energy efficiency standards should be allowed to attract funding through bonds deemed climate-friendly. Other areas where the Climate Bond Initiative is helping draft voluntary standards are in the field of agriculture and water infrastructure.
Caroline Cruickshank, managing director at BNY Mellon’s corporate trust business, notes that standards have also been helped by the emergence of sub-sovereign level investors. She says municipalities and provinces in North America have been “jumping on the bandwagon” as regulatory pressure increases to combat carbon emissions.
“They are looking to green bonds as yet another funding source to be able to tap capital specifically towards green use of proceeds,” she observes.
Despite the market traditionally being perceived as one dominated by development banks – and indeed, 2014’s largest issuer was the European Investment Bank at $5.6bn, followed by Germany’s KfW at $3.5bn – corporates have entered the arena in style.
Catherine De Coninck-Lopez, sustainable and responsible investment officer at Threadneedle Investments, sees green bonds as the greatest opportunity for carbon-conscious investors. The £500m (€649m) issuance completed by Unilever in 2014, the first sterling-denominated corporate, targeted a halving in the carbon footprint of the factories benefitting from the financing. Demand was such that yields fell after the initial offering.
“Speaking to my high-yield colleagues I do think that we are seeing companies where the yield curves have widened on issuers on the basis of greater rhetoric of climate regulation coming,” she says.
French multinational utility company GDF Suez raised $3.4bn to finance renewable energy and energy efficiency projects, offering investors 1.3% on an issuance with a six-year maturity and an increase of one percentage point on bonds maturing in a dozen years. The next big corporate issuer was Iberdrola, the Spanish public utility.
Search and rescue
In July 2014, at a time when the Climate Bonds Initiative estimated that the global market was worth $500bn (€434bn), programme manager Bridget Boulle admitted that discoverability of climate bonds remained a problem.
“There is still certainly work to do on discoverability and identification of product, and then packaging it in a way that is exciting for investors – especially institutions,” she said at the time.
She added at the time that indices had hitherto been used to help institutions discover opportunities, rather than benchmark performance – hard to achieve in a fairly limited market.
According to Barclays, which launched an index in conjunction with MSCI, the benefit of indices is that there is an independent evaluation of what is ‘green’. It permits entry into the universe of a range of bonds, ranging from green property that is certified under the myriad of schemes available, to pollution prevention and alternative energy sources, of which the latter segment formed the largest part at the end of 2014.
And as Linda-Eling Lee, global head of ESG research at MSCI notes, the green bonds market has the additional advantage of its scale developing at a faster pace than that of the impact-investing sector, measured at $50bn, while also offering an easy to understand risk-return profile for both those inclined to invest socially, but also those seeking return.
But how to prove that the money committed is having the desired impact in lowering carbon emissions? The task is fairly achievable when committing funds to issuances such as those by Unilever, or other projects that involve refurbishing buildings – it is a simple matter of comparing the unit’s output before and after. But this is not always the case.
Due to the predominance of development banks and other state institutions, these have also led the way in measuring impact. The UK’s Green Investment Bank charts the future reductions in carbon emissions due to its activity and estimated that the £1.3bn in capital committed in March 2014 would reduce carbon emissions by nearly 60m tonnes – equivalent to decommissioning 1.6m cars.
Whether the market takes off depends on whether or not the investment community at large becomes comfortable with the concept, and continues to feel it worthwhile. “I’m not suggesting that we have achieved 100% comfort today, only because there is still the concept of transparency that needs to mature,” says Cruickshank.
The success of the market, therefore, not only hinges on the fleshing out of the voluntary standards, but also the growth of issuers outside the public sector, to offer a well-diversified market no different than the current mainstream fixed income universe.