Wednesday, 12 December 2018

IFR Green Bonds Roundtable 2015: Part 3

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IFR: For issuers who don’t follow through with their green intentions, what is the sanction? Let’s say issuer X says: ‘we are going to do Y with our green bond proceeds’; they get a second opinion and we all think ‘fine’ but then six months or a year later there haven’t been any disbursements consistent with the stated use of proceeds. What needs to happen?

At the end of the day, I understand the market needs to carry on growing fast to hit that US$100bn target but in order to cement the market do we need to have some sort of green event, such as exclusion from a green index or something where the index providers take responsibility and sanction an issuer for not meeting stated intentions by kicking them out of the index thereby creating a flow of forced sellers?

Tanguy Claquin, CA-CIB: That’s an interesting point. There is no universally recognised gatekeeper of this market right now. There are second opinion-providers but they have different views. That’s one angle. And there are certainly the investors, but as Ulrik mentioned, they’re not real gatekeepers in that you can sell a trade to investors who don’t care about green aspects. You have the index providers. They’re another aspect.

We also have NGOs and organisations such as Climate Bonds Initiative playing a role; we may see others in the future. Market observers like Thomson Reuters may be one of them too. And then there are banks: we are all worried about this, and clearly, we will not bring a trade that we don’t think is good for our reputations. That’s why we drafted the Green Bond principles although we have taken the view that we should not dictate what is green and not green because we cannot go that far.

In the medium-term, governments or local regulators may put some incentives into their own markets and decide what they think is green and not green, but here again we will see different views. The Chinese are certainly different from the Europeans who are different from the US.

One element for 2015 will be: who is going to emerge as gatekeepers of this market?

Navindu Katugampola, Morgan Stanley: Bringing together some of your questions here, Keith, around mixed use of proceeds bonds, pricing and sanctions if you go off track. First of all, there’s nothing wrong with mixed-use bonds. The development bank bonds have multiple asset classes within them around adaptation and mitigation strategies for example. To Pernille’s point, if those asset classes don’t have credibility, however, if they could be considered non-green or are a much darker shade, that’s where you as an issuer start to lose your credibility. If you fail to meet the objectives you set out with, in respect to your investments in Green Bond eligible assets, you lose your credibility.

And fundamentally, that’s what it boils down to: credibility. When we’re talking to potential issuers of Green Bonds, the first thing they’re concerned about is not necessarily what positive PR they can generate but what the downsides are they need to be aware of, and what the potential pitfalls are. So in the same way as investors aren’t at the moment being asked to pay a premium for Green Bonds – the credit they’re taking is a corporate credit – the ultimate sanction on a company is their credibility as a Green Bond issuer and how investors respond to that.

IFR: OK so you have issuers like GDF Suez, EDF, Unilever etc that are coming up with green bonds; they’re expanding the market, diversifying their investor base into ESG/SRI money, which is all fine. But I just want to focus on the issue of hard ring fencing of revenues. So you say the proceeds of a new issue go towards some renewable project or some climate change mitigation project but ultimately, what the company is not saying to investors is you’ll be paid from the proceeds of that portion of our revenue.

Do you think that issuers, investors, the market need to take a stance on this and say: ‘look, we’re very happy to fund this part of your business but to super-charge our and the bond’s green credentials we want to be paid out of the proceeds of that business’. Is this segment of the market going to evolve, Stefan?

Stefan Reiner, Deutsche Bank: Isn’t there an element of self-regulation here? Issuers need to do reporting around this. Some do it annually. others do it more frequently. Investors have back-testing after reporting on where the funds go. So I would also call it responsibility of the issuer. If the issuer shows they aren’t responsible on their issuance, the next transaction shouldn’t work for them. The issuers I talk to are very into it and are doing their fundamental work, trying to screen the balance sheet and targeting sustainable issuance in the coming years.

They don’t want to do one-off Green Bond transactions. They look at them through their business profile and only if they are sure that they can bring new-issue transactions in the Green Bond format for the next couple of years will they do it. I would call it issuer responsibility; it’s a self-regulated market.

Pernille Holtedahl, DNV GL: I agree that it’s the responsibility of the issuer, the problem is that the whole market will suffer with a couple of bad bonds. So the consequences will spread to everyone if Green Bonds get a bad reputation. It’s not just a question of: ‘oh, it’s too bad for you’ No it could actually quickly bring down the Green Bond market. Now we have most of the bonds in their first year, reporting will become the determining question going forward. That’s why the reporting principle is part of the Green Bond principles.

But we have to make sure that reporting is properly done; some issuers should probably have verification of that reporting. I think that’s a good idea for a number of issuers and will add credibility. I agree with Tanguy that we need more gatekeepers, I don’t think the Climate Bonds Initiative is enough. I’m a bit puzzled by the lack of critical thought in the media.

Lastly, on the point of compliance, what’s interesting is if you look back, the Climate Bonds Standard says you have to have reporting and verification and if you fall out of compliance you lose the kitemark. When you’re talking more broadly about the Green Bond market, it’s less regulated and you don’t have that loss of a stamp.

Navindu Katugampola, Morgan Stanley: Just to answer your question around hard cashflow, I think at that point of time, you actually end up with something that is much more similar to a project financing. And I believe, to pick on some of the themes that Pernille outlined, the direction in which Green Bonds themselves are going to evolve is going to be driven by what we’re hearing from investors and their demands.

And the number one thing that we get asked about is reporting. So once you raise a Green Bond, you make claims about how you’re going to disburse the money. More than actually getting paid back via the projects, people want to know what these projects do, how they perform, and what they are. So the reporting element is the most critical so investors can readily assess the impact of their money.

Mike Wilkins, S&P: I totally agree, it’s going to be investors that drive the market forward. Ultimately they’re going to want to know about performance, about where the money is being used. They’re going to ask for transparency. So ultimately, in the same way as they ask for a credit rating, they’re going to demand the same level of information on the Green Bond in terms of how proceeds are used, and making sure there is no green-washing. So ultimately, we’re going to see the investors having much more of a stronger voice in the market evolution.

IFR: So on the reporting piece, some issuers run it as part of their investor relations function and run Green Bond updates through their quarterly updates. Others update it in the annual report. Absent gatekeepers as we’ve discussion, whose responsibility ultimately is it and who is accountable to make sure the reporting piece is up to standard?

Mirko Gerhold, Commerzbank: Green Bond features are multi-dimensional. Reporting is one thing; transparency another and there are so many other dimensions such as eligible projects; the time until proceeds are invested and so on. It’s very difficult to define a formula that gives you a percentage of greenness of a specific bond issue. And I think this is something very important that we need to take into account. It’s very difficult to come up with a definition for a Green Bond, of greenness per se that fits to any situation.

It’s up to the investor to decide if the overall package offered, including the transparency as a very essential part, fits their individual investment criteria. What we can do on our side is to guide issuers in the direction to provide the right standard of transparency, the right standard of reporting. Ultimately based on investors’ requirements and preferences, market standards will develop.

One main standard in recent bond issues is that many issuers have relied on third-party opinions. The more issues we see with third-party opinions, the more challenging it will become to issue a Green Bond without such a standard. And the same is the case on reporting and transparency.

IFR: Can the private sector learn from the public sector on the issue of reporting, Ulrik?

Ulrik Ross, HSBC: The public sector has state-of-the-art accounting and reporting mechanisms in place around their environmental profiles. Will corporates ever take it that far? They’re more focused on the corporate profile. But with the capacity they have, they will take it as far as they can and they will grow their CSR divisions over time, I’m sure. One of the things we were asked by the UK Green Investment Bank was to come in and look at accounting for the banking industry to create some kind of impact reporting on our balance sheets.

Going forward, we will get more requests from the general public, including on the accounting side. The sustainability report will over time become an integral part of the annual report. One of the hopes is that impact reporting will play a role in the future. We definitely need that to make a meaningful difference. So can the corporate sector learn from the public sector? I’m sure that they can, but there are a lot of other factors that will also push us in the right direction.

Tanguy Claquin, CA-CIB: In fact, in the corporate sector we have seen some issuers committing to impact reporting. It remains to be seen if they will do that, but GDF Suez, for instance, Unibail or Hera committed that they will report on the social environmental impacts. That’s an interesting development, because this is not in their mandates.

Second, this is quite European-driven for the moment and the increase in what is required to do in Green Bonds, such as second-opinion impact reporting is clear in Europe. Nobody would do a deal without that in place in Europe right now given the state of the market. But it’s not the same in the US or Asia. Another element key for the market’s development in 2015 will be to see if there is any convergence of interest among potential issuers in the Green Bond market in general but especially the corporate issuers in terms of their willingness to cope with the high standards that are now applied in Europe.

IFR: We haven’t discussed the financial sector as issuers. Do we think as a panel that the financial sector will grow, be it in terms of straight bond issuance, Pfandbriefe/covered bonds or other forms or green refinancing?

Tanguy Claquin, CA-CIB: If we reach a US$100 billion market, it will be thanks to the financial sector not the corporate sector. This is a debt market. Who’s financing the debt of infrastructure and renewable energy companies? It’s the banks. Who has the assets? The banks. So this is obvious. But in terms of simplicity to track these assets, if you have worked with corporates on a Green Bond, tracking the asset is not always that easy.

So the financial sector is obvious, and I think this applies to covered bonds, to ABS, to senior unsecured for sure. By the way, commercial banks can lead the way in this. Credit Agricole CIB has issued more than €1bn and because we are a big project finance house, we have a lot of green assets. So we have started to issue and I expect more to come in the future. The SSA sector has shown its leadership, it’s now our turn to show leadership and demonstrate that because we believe that much in our market, we issue ourselves. Basically banks should walk the talk.

This is one of the developments I expect for 2015. And that may drive the market to the US$100 billion, more than the corporates maybe. The things we’ve discussed in this conversation are putting more constraints on the corporate space. It’s a bigger leap for a corporate to issue than for a bank.

IFR: When we talk broadly about ESG and sustainable bonds, do we need to separate green from ESG as over-arching themes? They clearly cross over at the margin but they can actually be quite different things.

Navindu Katugampola, Morgan Stanley: What we hear in particular from the European investor base, which has a much longer history of integrating ESG investing into their mandates, is not that they have a specific objective with respect to climate change, but rather there’s a whole range of social, environmental, and economic issues that they are conscious of that have a bearing on how we actually evolve to a more sustainable society.

Those aren’t just climate change, they’re broader environmental considerations, they’re to do with healthcare, they’re to do with education; they’re to do with access to food, to water. So how you actually approach sustainability necessarily and ultimately has to be a holistic consideration. And you’re right that the majority of issuance to date has been very closely focused on the environmental side, and in most cases, very closely focused on the climate side.

But what we can actually do is take those lessons and apply them much more broadly. I think that’s critical, because, again, a lot of what we’re hearing from investors is that they increasingly want to focus on a broader range of impact investing objectives to help support some of these solutions.

IFR: Pernille does your mandate stop with green? Will you go down the broader ESG route?

Pernille Holtedahl, DNV GL: We’re happy to do that. We would just want to be clear and perhaps discuss what we call the bond i.e. if you call it a sustainability bond, or Green Bond just so it’s clear to the market what it is. If it is green, I’d like to see something environmental in it. I’d like that to be dominant, but we could come up with other good names for bonds in this space. And you can adapt the Green Bond principles. That’s not a problem.

Navindu Katugampola, Morgan Stanley: In the meantime, the major challenge is actually trying to quantify and objectify the results, which in the Green Bonds, the climate bonds we’ve seen, is very easy because you’re looking at carbon reduction, or waste reduction. But as we start to look at social factors, it becomes more difficult to objectify or objectively assess the impacts of your investment.

IFR: Right, because out of the supranational stable, we’ve seen food security bonds, youth unemployment bonds, microfinance for women in EM bonds and others. These are all laudable goals but I’m curious to understand when you guys talk about sustainable capital markets how you frame that internally and to what extent the discussion goes beyond climate change.

Ulrik Ross, HSBC: It started with green because there was a very clear link to impact reporting – you could measure it and it was very tangible. When it comes to the social scale and the other themes, it’s very difficult to make it tangible. I think that’s where we are at the moment: people can mobilise around something that is tangible.

It’s difficult to mobilise funding around something that is less tangible but there is definitely a feelgood factor and some dedicated demand focusing only on buying social bonds. Will we see the same rise of wallet outside green versus non-green? I don’t think it will rise as quickly; it will still be a very niche area. People understand green and can mobilise around green, and that’s why it started there. But clearly over time, there’s an increased need for more products, and we’ll definitely welcome it and follow it very closely.

Mike Wilkins, S&P: In terms of the green and environmental markets, there is now an increasingly strong connection between environmental risk and financial performance, and financial risk. The stranded assets debate has evolved to the point where most investors understand if you’re going to invest in brown or black assets, you’re increasingly going to stand the risk of having some financial impairment. And that’s not something you can equally associate with social risk. So that’s why the Green Bond market or the climate bond market is more likely to grow than the other side of ESG.

IFR: How much of the growth and evolution of this market has been down, if at all, to underlying bond market technicals, which have been conducive to pretty much anything that has come out?

Tomas Lundquist, Citigroup: Well technicals have certainly, been strong in the past year but this hasn’t been the driver. There have been other elements that we have discussed. I agree with Tanguy that financial issuers will probably be a driver of

IFR: Shouldn’t Norwegian hydropower bonds be included in the green universe?

Pernille Holtedahl, DNV GL: I understand from MSCI, which included hydropower up to 25MW, that that was a random cut-off point. I don’t particularly like hearing the word random this context but they’re backtracking on that. It was a learning curve for everyone. Hydropower is one of the areas where context matters. If you have a run-of-the river hydro power plant in Norway or in a temperate climate from the 1950s, it’s not going to have any real negative impact. But it might in a tropical country. Hydropower is the only one I can think of right now where contextuality in terms of the bond matters, where we need to dig a bit deeper and do our research and make sure we say the right things.

IFR: Before we finish, I wanted to go around the table and ask you to make some concluding remarks. What are your expectations, hopes and dreams for the Green Bond market in 2015? What needs to happen? What would you like to see happen? What are your top one, two, three top wish list agenda items?

Mike Wilkins, S&P: The easy wins will be increased transparency, reporting and monitoring. But the key thing for me – and I’m talking personally here – in terms of Green Bonds developing is there’s got to be an impact between greenness and bond pricing in the same way as there’s an impact between credit rating and pricing of a bond.

Until that really happens, there’s going to be a cap in the growth of the market. Once you see investors differentiate between bonds which are green and not green and the way they are priced, that’s really going to make a huge difference. And when we get to that point, I think we’re going to see even stronger exponential growth in the market than we’ve seen so far.

Navindu Katugampola, Morgan Stanley: There are three things I’d like to see: first of all a broader range of issuers access the market across geographies, including the growth of Asia and Latin America, but also in terms of the types of issuers. Tomas hit the nail on the head on this: I would like to see more companies like Unilever across a range of different industries accessing the market as well.

The second thing I’d like to see are larger, liquid deals. Billion dollar-plus deals have been relatively few and far between. Larger liquid deals encourage more investors to participate in the market. And that’s the third thing that I’d like to see: more investor focus on this area. This is a theme that is going to continue over 2015. And to the point that Ulrik made earlier, rather than dedicated funds in isolation, it’s predominantly going to be the large money managers asking themselves whether this product can be appropriate for them.

Mirko Gerhold, Commerzbank: I hope the market continues to grow further not only in size, but in the number and diversity of issuers. We have seen a large increase in market size but the number of issuers that have come to the market is still somewhat limited.

Secondly, I would hope the incremental demand becomes more tangible, that we see more and more investors focusing on the greenness of a bond issue. Because this is a pre-requisite for potential positive pricing impact. And last but not least, I hope for a continuation of the standardisation both in terms of the general initiatives like the Green Bond principles, but also in terms of market trends based on investors’ expectations and requirements.

Stefan Reiner, Deutsche Bank: I would like to see the market develop in terms of more products. Many issuers these days only think about euros and dollars when thinking about Green Bonds but issuance should diversify toward the niche currencies and to products away from plain vanilla bonds, such as private placements. There are many smaller investors who would love to invest in the product and gain exposure to a tailor-made product but we as an industry probably don’t offer that in a broad-enough range right now. And then the dream is certainly pricing. In the future, investors will have the mandate to buy into lower yielding bonds if they qualify for sustainable and Green Bonds.

Tanguy Claquin, CA-CIB: I believe the United Nations Framework Convention on Climate Change (UNFCCC) Conference in Paris in 2015 (COP 21) – which should be the next binding agreement between countries to finance climate change mitigation – will have an impact on the market. I don’t know what this impact will be. It may spur further issuance but it may also distract people from issuing Green Bonds or it may frighten some others away. There are many scenarios but this will be a focus event because it will be very high on the political agenda and will have a high media profile. So that’s one expectation.

On pricing, my dream runs counter to that of Stefan: I hope the price remains exactly the same as other transactions. I expect market supply and demand will drive the pricing but I hope nobody tells anyone at any point that mitigating climate change should be more expensive than not. That’s one of the very strong requirements for the market to grow.

Ulrik Ross, HSBC: Hopes and Dreams. It’s a good title. If we are to realise the dream of being able to mobilise 5%-10% of the bond market capacity of eligible issuers on a frequent basis as the backbone of the Green Bond market going forward, we need to have a strong framework, potentially included in EMTN programme documentation, so we move to standardisation on the documentation side. That will be a development.

It would also be nice if we could get a system that will compare frameworks and opinions from independent opinion providers. That will be visible to both investors and issuers so we can easily rally around that, and optimally also include impact reporting.

If we are to get volumes up – to US$100 billion in outstanding stock under the Green Bond Principles by the end of 2015 and to US$160bn the year after – we need to mobilise across the asset-class from project bonds and infrastructure to build a sustainable growth strategy globally.

We need to mobilise around not just liquidity but also risk-taking in the right structure for the right projects. We need to mobilise one percent of the world’s GDP to sustain the two degree Celsius increase within the infrastructure space. So clearly if we can get the right risk-taking model in the equity and the mezz space for project bonds to support that, that’s a good thing.

The green growth fund, which has recently been established on a UN mandate, is very welcome, as is the US$10bn support mechanism for it. And then in the end, I would say that we need to raise awareness and mobilise both investors and issuers engaging in this market. We’ll do that via the points I’ve mentioned above, but policymakers need to play their part too. They need to stand up and support the facilities we are starting to develop. Investors and issuers need to see this from a price-neutral point of view as Tanguy also mentioned. If fiduciary mandates don’t allow investment into climate protection, that’s a bad thing.

Pricing should stay as it is. If it develops positively for issuers over time, so be it. But clearly you should not be penalised for investing in the environment. I hope we can all agree that raising awareness will help us to invest into economically viable and sustainable investments. At the same time we can do some good for society and the environment

Tomas Lundquist, Citigroup: I started out working in New York and came to Europe at the inception of the euro. The European market is the leading market globally, both on the issuer side and on the investor side, which is truly phenomenal. When I started working in Europe around 2000 that was not the case. The European market was in its infancy versus where we are today.

So this is in itself very positive. Many of the points have been highlighted such as the need to broaden the number of issuers, industries, geographies, and it would be a key goal trying to move as much capital as possible into the sustainable investments that the world needs, which would be clearly beneficial. All of us are very excited to be involved in this field.

Pernille Holtedahl, DNV GL: I have three things on my list. One is very prosaic: I hope the Green Bond principles are amended and updated, which I think they will be. How pure-play investors treat general corporate purpose bonds just has to be clarified. I speak to issuers who feel nervous about this because it’s not currently included.

I think the novelty of Green Bonds will start to wear off quite soon so at some point, we need to see more tangible benefits. I’m not sure what they are, but at some point some issuers will start saying: ‘I’m just not going to bother, I don’t see the point; I’m not going to get any advertising from this’. That will be interesting to see.

And I would love to see more market growth as long as it is meaningful. So if it’s going to be green it actually has to be green. Particularly for energy efficiency-related bonds, we need to start seeing performance metrics so not just building according to the local building codes, which anybody can do, but something saying we’re going to achieve 40%, 30% achievements in terms of CO2 reductions or whatever.

IFR: Thank you, everyone, for your very insightful comments. It strikes me that the market has reached a pretty incredible state now but as we’ve discussed a lot more needs to happen to make this market sustainable into the long term. We await further market developments with keen interest.

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