More than 600 delegates from 40 countries packed London’s Guildhall this week for the Climate Bonds Initiative’s annual conference and Green Bond Pioneer Awards. And – like the light streaming through the stained glass windows of the Great Hall – the mood was (mostly) sunny.
With good reason: according to Henry Shilling of rating agency Moody’s, which has recently launched a green bond assessment tool, issuance could reach $206 billion in 2017, up from $81 billion in 2016. This would place the path for issuance well on the way to the $1 trillion that some are predicting by 2020.
Philip Brown, head of Sovereign, Supranational & Agency debt at Citibank, summed up a view expressed by many during the day, that the recent French government sovereign issue, both in its size and its long term, had been “transformative” for the market. The 22-year bond raised EUR 7 billion and – perhaps most significantly of all – undercut the pricing of ‘vanilla’* sovereign debt: the 1.741% rate at issue was lower than the average 2.0% rate for outstanding French debt (of a far lower maturity overall).
Green bonds are one of the ways France is going to meet its Paris goals; every government is now thinking about doing one of these
“What’s not to love?” Brown said. “The issuance is deep, it’s liquid*, it’s probably going to outperform against normal French Government bonds on price over its lifetime, and because it’s a green bond you get all the disclosure on use of proceeds as well. There is no downside. This is one of the ways France is going to meet its Paris goals and every government is now thinking about doing one of these.”
As an example, Brown cited the expected Nigerian government issuance later this year, saying that “the green bond framework Nigeria is putting in place is giving confidence to investors on the quality of assets that will be financed and the integrity of standards. This will attract new investors to Nigeria.”
(This last point is indeed a telling one if it turns out to be true: perhaps as well as helping save the planet, the additional disclosure around green bonds will help to resuscitate the reputations of markets that have been clouded over the years by lack of transparency.)
The role of central banks in the development of national green bond markets was also emphasised by Kenyan Central Bank governor Patrick Njoroge. “Central Banks have a major convening power. Having accepted that green finance is the coming wave, we have to drive this through the rest of the financial sector in our countries. The global architecture of finance is changing, and we need to make it clear to everyone we deal with that it’s easier for them to make changes accordingly now than it will be later.”
Motoko Aizawa, Senior Fellow at the Climate Bonds Initiative, saw another dynamic at play at the national government level. “To date, public-private partnerships (PPPs) have been pretty much the only game in town as a way of attracting in the private sector. We believe that governments are seeing that those type of arrangements aren’t suitable for long-term, uncertain investments like many of those directed at climate change. They will be looking to green bonds to increasingly take their place.”
Mike Eckhart of Citibank also noted that it was a common misperception that green bonds were all about project finance. Of total project finance lending of $380bn, only $16bn had been in the form of bonds. 95% had come from banks. Pointing out that the vast majority of vanilla bonds are on corporate balance sheets, he predicted the same would be true of green bonds.
Green Securitisation on the rise?
Chris Knowles, climate action head at the European Investment Bank, called for securitisation to make a return as a key financing instrument and an asset base for green bonds.
“We need aggregation and securitisation of assets,” he said. “Green projects are often very small, relatively speaking, and distributed across countries and regions. When it’s properly done, securitisation is a great tool, but to see it work in the climate change space – to see real investor demand – we need better guidelines, standardised contracts, warehousing* capacity, possibly also credit enhancement*.”
“But we also need to see a greater supply of assets that institutional investors can buy into,” he said. “One way of creating this would be for development finance institutions (DFIs*), which often finance these assets at the outset, to be prepared to sell them on, much more routinely.”
Where to for DFIs?
Emphasising that he was giving a personal opinion not an institutional one, Knowles also said that he had seen a morphing of culture at DFIs over time, leading to the mindset of a lending institution overtaking that of a development institution. “We have become focussed on asset accumulation, growing our own balance sheets, rather than catalysing private sector investment.” He noted that the EIB’s mission had recently been quite radically redirected by the European Commission, with a target to achieve leverage of €15 of co-investment for every €1 of EIB investment.
He therefore called for all DFIs, including new entities such as the Green Climate Fund, to “think very carefully” about how they positioned themselves in terms of risk appetite, so as to maximise mobilisation of third party resources to bridge the sustainable infrastructure finance gap. (A gap which, according to Michael Wilkins of rating agency Moody’s, is widened by some $150 billion annually by the need to add climate resiliency to infrastructure.)
Leslie Maasdorp, CEO of the New Development Bank (NDB, a DFI established by the BRICS countries) echoed the need for MDBs and DFIs to reflect developments in markets and needs. While the NDB would be replicating the commercially oriented business model of current DFIs, he noted that the bank has a legal mandate to do green infrastructure, and would also be focussing on developing local currency instruments and local capital markets.
What’s needed to grow the Green Bond market even further?
Asked about other developments and innovations needed to continue the scaling of green bonds, panellists mentioned priorities ranging from the nitty-gritty of investment processes to changes in culture. Needs included the following:
- Standardisation and common language on definitions of green projects
- Broadening and deepening hedging products, including products attractive to institutional investors
- Fiduciary duty to be seen as much wider than just financial return
- The growth of responsible investor networks outside Europe and the USA
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There’s a grassroots demand bubbling up that has nothing to do with politics. Green bonds give people a chance to ‘vote’ on issuer behaviour
Looking forward to further developments during 2017, Suzanne Buchta of Bank of America predicted the growth of green bond funds (i.e. funds investing in GBs) and the emergence of exchange-traded funds (ETFs*), which appeal to individual investors.
Speaking of the American market, she said, “there’s a grassroots demand bubbling up that’s not dependent on politics.” In fact, she noted, “green bonds are the debt equivalent of ESG and shareholder activism in equities. They give people a chance to ‘vote’ on issuer behaviour via the bonds they choose to buy. They are actually empowering for smaller investors in that way.”
Henry Shilling of Moodys’ also saw an increase of non-investment grade issuance on the way. “About 30% of vanilla corporate bond issuance is non-investment grade,” he said. “The proportion of sub-investment grade green bonds is tiny at the moment, so that’s an inevitable development as the market matures.”
Such an outcome would, of course, be helpful for riskier projects and for countries with sub-investment grade sovereign ratings. Shilling also predicted that as demand grew there would a shortfall of product, leading to a price increase and maybe stimulating the growth of a secondary market. Philip Brown of Citibank, however, saw the fact that green bonds were ‘stickier’ than plain bonds in investor portfolios as a vote of confidence in their quality as a long-term investment prospect.
The range of issuance now on offer in the green bond market was emphasised by the awards handed out at the end of the conference. Geographically, these ranged across the world from China (still the market leader by a distance) to Poland, the Philippines, Costa Rica and Morocco. Thematically the award winners ranged from financial institutions to airports, and in terms of layers of government they went to regions and municipalities as well as sovereign issuers.
The elephant absent from the room …
One thing, though, that was in not at all in evidence during the day was any linkage to the NDCs. While attending most of the sessions and listening more or less intently throughout, I don’t think I caught these initials being uttered more than a handful of times.
Does this matter? Arguably the fact that the green bond market is taking off and appears to have a bright future is the most important thing. Yet the danger remains that without any linkage to Paris, what will happen is that issuance will gravitate to the lowest hanging fruit (renewable energy, energy efficiency and green real estate in developed and larger/easier-to-access emerging economies). The result of that outcome would be that the potential – indeed the need – for green bonds to address wider asset classes may not be developed.
Along with his call to keep picking up the pace of issuance, this is why Climate Bonds CEO Sean Kidney is right to continue to call also for ‘climate investment plans’ that generate long-term investable pipelines out of country NDCs. “This is where the multilateral development banks (MDBs*) and DFIs, alongside donors, need to step up to the plate far quicker than they have to date,” he says. “To bring forward the identification and plugging of capacity and policy gaps that will allow countries to identify the projects that can be financed by instruments like green bonds.”
In particular, policy makers and governments need to support DFIs in taking a more active role in risk-bridging, providing the political momentum for this shift.
“That’s the win-win-win,” Kidney says. “The countries get the investment for the projects they need, the bond market gets its pipeline, Paris gets the more ambitious outcomes that are vital for the 1.5°C-2°C result. But all the actors aren’t on the stage yet, let alone having learnt their lines. We need to accelerate, we need to get the full cast assembled to get this show properly on the road.”