IFR Green Bonds Roundtable 2016: Part 1
IFR: Welcome to IFR’s second annual Green Bond Roundtable. Once again, green bonds have been one of the biggest talking points in the debt capital markets. This discussion is taking place, of course, in the shadow of COP21. Ulrik: can you summarise the outputs from COP21 as they pertain to financing the de-carbonisation agenda?
Ulrik Ross, HSBC: When you look at COP21, there is huge engagement from the political side, the business side, NGOs and from the general population. We didn’t see that in Copenhagen in 2009, so clearly we have come a massive way since then. We have a commitment and a plan from a sovereign point of view to make change. We didn’t have that in Copenhagen either, and the biggest sovereign carbon-emitters are the ones that are now leading the discussion.
When you look at the success of meeting the 2oC cap, the willingness to make a change is definitely there. We in the banking industry are trying to come up with products and innovation that can help that from a policy point of view as well as a financing point of view. I am very encouraged by what I would call the ‘holy grail’: the engagement of the world in the climate debate, and I think we will see a very positive reaction.
Hopefully, this is just the beginning of something very big and something significant for the globe. I believe that we are on the right trajectory to get to a two-degree outcome. It will come in steps, but it will definitely come. We have climbed a mountain since 2009.
IFR: Philip, are you comfortable that the banking sector is doing all it can to engage with the process?
Philip Brown, Citi: I think so. That’s illustrated by the impressive acceleration in membership of the Green Bond Principles at ICMA. More than 100 institutions have become members [109 as of February 4 2016] and 56 banks have signed up to comply with the Green Bond Principles.
If we look at the role that green bonds have played, we saw around US$37bn of issuance in 2014 and we surpassed that in 2015 with almost US$42bn. But the main development and most exciting development from my perspective in 2015 has not really been the volume of issuance; it’s been the amount of investor interest in this sector, which I think prepares the ground for far greater issuance in 2016.
Although these are substantial amounts, COP21 talks of much bigger numbers necessary to limit climate change to two degrees. The International Energy Agency calculated ahead of COP21 that unconditional climate pledges made by over 150 countries will require cumulative investment of US$13.5trn in energy efficiency and low carbon technologies out to 2030, which is an annual financing requirement in the range of US$900bn over the next 15 years.
We’ve really only just started to scratch the surface so far in the shift from ‘billions to trillions’. We haven’t got there yet, but it’s very clear that the world is far more focused on the issue today than it was even a year ago, never mind back at the time of Copenhagen.
IFR: Looking at the new-issue data for 2015, Mirko, the numbers have undershot that US$100bn stretch target that was set at the end of 2014. Philip made the point that it’s been more about investor engagement this year as opposed to primary issuance. That’s fine but it would be easy to look at this market and be disappointed. How should we view progress in 2015?
Mirko Gerhold, Commerzbank: I think there has been a lot of progress because there has been a lot of engagement on many different levels. Investors are just one area: we’ve seen investors state clear expectations towards the green bond process and features. We’ve also seen initiatives on impact reporting; and we’ve seen developments on the Green Bond Principles with a lot of additional members joining the initiative, as Philip mentioned.
Whoever you speak in the capital markets – be it issuers, be it investors, be it banks – everyone is looking at this topic. There is a huge awareness of the potential and importance of climate-related financing in general and the green bond market in particular. So we shouldn’t just look at the pure numbers but take a more holistic approach and look at all the different things that are happening at different levels.
Joop Hessels, ABN AMRO: A lot of issuers are just starting to look at this market. And where maybe they initially saw this as a small niche market, they now see their peers and competitors not just looking but successfully entering the market. They’re keen to learn more about it and to find out what needs to be done; how it works; how they can extract the requisite kind of information from their systems. So very practical discussions in many cases based on the ambitions of a company itself.
This now needs to drip down from the company-level approach towards treasury. And absolutely there are a lot of ambitions there, so it’s good. There are still some big markets that need to open up. If they do open up, there will be much more to grow towards.
IFR: Justin, you’re on the other side looking to buy this stuff. If we break down 2015 issuance, there’s been a lot of public sector issuance from agencies, supranationals, municipals, cities and so forth. The corporates that have tapped the market have been predominantly renewable energy companies but there hasn’t been many brown energy companies looking to transform their businesses. When you look at the issuance to-date, what’s your take?
Justin Eeles, Affirmative Asset Management: I think it’s been very positive. It obviously started with the supranationals and sovereign-related entities. I can understand why municipals and local governments should be large issuers because it can be a way of keeping a certain amount of the budget focused on a particular issue and if you can tie up your budget with that type of spending, it’s a way of getting away from potential political changes in the future.
So it’s no surprise to see that area growing, particularly when there are individual projects that are very easy to identify tied up with a green bond. The corporate side has grown. Certainly the number of issuers has grown and overall issuance has grown. The percentage of supranationals has fallen within the total, so it shows that the market is developing.
But in terms of absolute sizes I would have thought that the supranationals and government-related entities are going to stay very large in this market because it’s a way of mobilising significant amounts of capital. A corporate by its nature is not going to be borrowing as much in significant size.
IFR: From a definitional perspective, why focus on labelled green bonds as opposed to unlabelled climate bonds?
Justin Eeles, Affirmative Asset Management: To start with, it’s because [labelled issues] give us a structure we can focus on and we can work out the differences between the structures and identify which ones we think are good and which we think are less good. This is something useful that we can offer to an investor who wants to put money into this field.
Going forward, the scope will expand as the number of issuers grows as labelled and unlabelled issuance grows, but for us it’s just purely resources at the moment that constrains us more to labelled issuers. And we don’t just look at green bonds; we’ll look at use-of-proceeds bonds as well because I think the use-of-proceeds model is a very important one for the future.
IFR: Bodo, let me come to you. Berlin Hyp entered the green bond ecosystem in 2015 with the world’s debut green covered bond, which was some feat. Can you take us through the process?
Bodo Winkler, Berlin Hyp: Berlin Hyp reserved the rights combined with the ‘Green Pfandbrief’ trademark as early as in 2009, so we were already having initial thoughts about how we could issue a green Pfandbrief that far back. But there were certain points that kept us from issuing. The first one was the legal aspect; we initially thought it might be possible to set up a different cover pool for green purposes only, but the German Pfandbrief Act does not allow that.
The other issue was that we might not have had enough assets – in the form of financing green buildings – to do it. That changed over the years and in 2014 our board decided the bank’s treasury should come up with a proposal as to how it all could work. We spoke to a lot of market participants and at a certain point became convinced we could issue a green Pfandbrief. The more time we spent on this topic, the more convinced we became that we really wanted to do it.
The second major element is the fact that we have one very big buyer of covered bonds [the European Central Bank] and we feared at the end of the 2014 that other investors might move away from the market simply because of the lower interest environment, because of negative spreads and the fact that one buyer was able to buy up to 70% of every single issue. In that environment, we wanted to diversify our investor base and felt that a green bond might be a chance to do so.
There was a third, very important reason: Berlin Hyp is a commercial real estate financier. If you look at the commercial real estate market – not only in Germany but in Europe – there’s been a big trend towards more sustainable properties. The tendency today is for real estate investors to get their properties certified around energy efficiency, so we wanted to reflect that on our liabilities side as well as the assets side.
We felt that issuing in the international capital markets under the umbrella of an instrument with a very long track record with no insolvencies and no investor ever having lost any money would be sustainable by itself.
IFR: In terms of the green tests on the assets side, do you have your own framework or are you employing external frameworks?
Bodo Winkler, Berlin Hyp: We had to develop our own framework. I think that is a task for every issuer. We defined what we considered a green building and asked ourselves how we knew that they were really green. Energy efficiency was very important for us, but other environmental aspects too such as water and waste management.
We had our own framework but we put it together with the Green Bond Principles so we defined use of proceeds, set up the reporting, [figured out what to do] about the management of proceeds and had a proper process installed for the selection of projects that should be eligible.
IFR: Magnus let me come to you. Cities have been relatively big issuers of green bonds in Europe, and the City of Gothenburg has embraced the concept. Can you talk about your approach to the green bond market, what difference it has made to the city’s finances, about sourcing projects, and transparency on the reporting side?
Magnus Borelius, City of Gothenburg: Green bonds have changed the way the treasury works insofar as no one really cares that much about the treasury as long as nothing happens. But with green bonds you suddenly start to realise that you can do something with the treasury. It’s the treasury that is stepping up here. We have a policy right now that the treasury should contribute to the city’s sustainability targets. And that means go ahead as fast as you can with green bonds.
We are a large municipality: we have the largest port in Scandinavia, we have our own amusement park; we have real estate companies and a lot of corporates so when we choose projects, it can be everything from tree planting to a harbour facility or whatever. Tracking the management impact reporting can be quite difficult so we are working hard on that.
Investor relations activities have changed a lot as a result. We have investors actually visiting us. They want to see where the money is going. They want to go and visit the different sites; they want to see that they really exist.
[Our green bond activities] also impact investor relation activities for ordinary bonds because we have green bond questions around that as well. You can’t separate the two. You can’t have two portfolios because investors are also interested in what you are doing and what you have set up on the green side. It has changed how the treasury works.
On green bond proceeds, we tell investors if the money is going towards public transport, smart grids, water and waste management; we have seven or eight areas. When we publish the annual report there is a list of exactly what projects we have allocated the money to. We also have a letter that we send out to investors; and we have information on the city’s financial webpage.
The largest investment for the moment is in biogas production and then it’s water management and water purification and that is for SKr700m-SKr800m. The smallest amount is for tree planting. We wanted to show the wide range of projects you can use green bonds for.
IFR: Aldo, the EIB has been issuing climate bonds for quite some time. But let me ask you this: given that the EIB, like many supranational entities, operates under an environmental/sustainability framework, shouldn’t everything that EIB issues be sustainable?
Aldo Romani, EIB: Of course the criteria of the EIB and the way in which it proceeds are of the highest quality and follow a system of institutional and legal references that secure that what we do is done in the best possible way. We pursue many different policy goals in many different areas. It is true that the EIB has a commitment in terms of signatures every year that amount to 25% of the total number of signatures in a single year that needs to be dedicated to climate action. And we have been able to deliver that.
What our green bonds focus on is renewable energy and energy efficiency, with the addition of a number of filters that make sure investors have the opportunity to look into the best possible forms of what we consider climate finance.
But thanks to the involvement of investors, green bonds have shown that there are indeed big issues with regard to the comparability of data across different lenders. You do not have the perception that this exists thus far with regard to environmental funds in general; it is very fuzzy. The whole system needs to be transformed and in this regard green bonds are the litmus test, the trailblazer, for this. This is really the essence of what happened in the course of 2015 and it has put pressure on the largest issuers to make progress in these areas and show the way.
There is a difference between the commitment to deliver certain volumes of finance and accountability vis-à-vis what is delivered in practice. Just to mention another point: there is a distinction between signatures and disbursements. So how do actual disbursements follow the signatures that you have achieved in a single year? This is the purpose of green bonds.
This not only has a quantitative dimension; it also has a qualitative dimension. It is a fine distinction but it is essentially understanding the value of green bonds per se.
If you really want to have accountability of this kind, you have issues that pertain to definitions in the first place; you have issues that pertain to prioritisation of areas with regard to policy goals that eventually need to be attained or pursued; you also have issues that pertain to measurement and methodologies to follow in order to assess the actual impact of what you do; and you have issues that pertain to reporting.
All of this turns ideally into showing that you have created the conditions for this accountability in appropriate monitoring of what is actually happening. One of the structural limits to the development of size is how much people are prepared to report with transparency given these parameters.
So when you look at green bonds, you shouldn’t look only at size but at what green bonds have that is peculiar to them, which is accountability in a higher form than was formerly the case. Maybe it is also important to find some common ground around the opportunity to create a performance indicator in your institution. And through that, effectively anchoring your reporting around a higher degree of accountability.
I would describe green bonds not only as a product but a process; a process of clarification that has started at the EIB and has already induced important results in the relatively short space of time in which the market has seen big market developments. In fact size has become a game changer because the more the dedicated portfolio in your treasury increases, the more external stakeholders have the opportunity to look in detail at what you are doing.
On your specific question, yes it is true the EIB is unique in terms of its institutional background [around sustainability] and in terms of legal background. But there are different contributions to different policy goals and we have de facto started the process of clarification that has induced a lot of discipline internally.
This has induced some very attentive due diligence (which I managed last year together with my colleague Dominika Rosolowska). It started with eligibility criteria and has gone through 16 different divisions and six different directorates. The result has been implementation of a new administration.
And, on the same date as the publication of the Green Bond Principles update in March 2015 came disclosure of our new practices which highlights the two motors of the market: having the right balance between stringency and flexibility required to get new issuers in, and the development of best-practice by market leaders and those that have the expertise as a reference point.
We will not attain results of a qualitative nature beyond quantitative commitments if the improvements I have referenced are not achieved. The International Financial Institutions issued a “Joint communication on a revised proposal for Green Bond impact reporting harmonization” on December 2. That revised proposal was supported by 11 international financial institutions. It was only four in March.
This is a step and a platform for further discussion towards a higher degree of accountability and transparency. The EU Council conclusions on climate finance included for the first time a reference to green bonds and to the need to secure higher accountability of actual flows. And by the way, this was an issue that was recognised at COP21.
Charles Smith, EBRD: The question you asked Aldo and the EIB is highly relevant for the EBRD because we have a unique situation in that our charter includes a green element and our mandate specifically says that we have to promote environmental and sustainable development. That means we have the resources internally; we have the set-up and we have almost 25 years of experience of green investments in our region. We also have extensive reporting around that, including our flagship report, the Sustainability Report.
When we set up our green bond programme we had a lot of thoughts and discussions with green investors to pinpoint what we could do to make a distinction between what we do generally as a part of our green mandate and the assets that we would select for our green bonds. It was a very useful discussion and it helped shape our eligibility criteria because the programme we wanted to set up was a small dedicated dark green bond programme.
We have criteria in our programme, for instance, that set a 90% hurdle. That means at least 90% of the funding for any project that is eligible for our programme has to go to environmental purposes, which I think is relevant in the context of, say, energy efficiency projects where you can have various modules that are not all environmental. I am not saying that doing it any other way is wrong but for us in terms of setting up a dark green portfolio, these are the details where we felt we could go the extra mile.
IFR: Thinking about that in the context of your geographical remit of the eastern fringes of the EU all the way to Central Asia, has finding bankable dark green projects been difficult?
Charles Smith, EBRD: If I look at our green project portfolio, it amounts to about 10% of our total operating assets. We are very stringent in finding very dark green projects. But I can also turn that around in that our region has not been very energy efficient so there is a lot of catch-up we can do.
There is tremendous potential for us to do things. We have a pragmatic approach and we look at our projects holistically. When it comes to some projects around renewable energy, for example, our approach is: “yes, we can do it if it makes sense”. But you have to take into account the entire social structure, including the political situation and national security, and sometimes a state-of-the-art renewable energy project is simply not feasible. These things can’t be changed in a day so it is clearly a transition process, which is the basis for our mandate.
IFR: Coming back to some market issues, Ulrik, what happens to the evolution of the green bond market in the event of rapid US policy tightening and the move to a wider spread environment? I’m thinking here about the costs of issuing a green bond relative to a non-green bond. Do you have any concerns that higher absolute funding costs might translate into less of a green focus? Could market conditions derail the evolution?
Ulrik Ross, HSBC: The bigger question is how the market develops going forward and what the drivers are behind it. Within that, it’s also important to understand the price dynamics. There are two things under discussion globally by leading governments, regulators, issuers and investors. One is how we scale up the market. The other is how to create the necessary risk capacity globally to come up with the projects that are needed to reach a two-degree world or contribute positively to climate-change agenda.
With regards to risk capacity, the next question is: does that lie with the public sector or the private sector? Who should wear what risk; when and where and in which phase of a project (greenfield versus brownfield)? We have a lot of new initiatives that are being mobilised around that, like the Green Climate Fund. The EIB has developed new products as well to help mitigate these things, you also have the UK Green Investment Bank, and we will continue to see new funds and structures being developed to play a role as the market develops them.
But that does not cover the global aspect of risk capacity, so we need to ask sovereigns what they are doing to help facilitate the gap that exists there. The second thing is how to build scale, how to get the US$59trn of assets under management under the umbrella of the UN Principles of Responsible Investment mobilised into the gap of US$53trn that has been estimated by the World Economic Forum that needs to be invested until 2035.
Banks’ balance sheets are not the place to go right now for this with increased regulation, so the capital markets have a very important role to play. We are talking about needing a trillion dollars annually to finance the gap that exists in the current situation.
The green bond market only produced US$40bn of new issuance in 2015 [approximately US$100bn outstanding at Jan 2016] so there has been a lot of focus on size. But the real focus should not be about the size of the market but about the role the public sector should play versus the private sector. If we are to get volume and the capital market to function we need public sector involvement.
We need either governments and regulators to step up to create a tax-incentivised model or an RWA-efficient model or provide direct subsidies like you have seen for example in the muni market in the US or in the SME market in Europe, which has been discussed under Basel III. We need a similar discussion around green bonds. China is leading the way and has taken a number of steps to come up with a new model that might be a global game-changer for the green bond market.
Where do we go in 2016? Will it be driven by rates or credit-tightening and is there a home for green bonds? I think the real question is more about what the dynamics of a new market will be. Will governments step up and realise that the capital markets are needed to facilitate the bridge? And will they contribute in an efficient manner that will drive pricing for issuers so they can achieve a cheaper cost of climate engagement?
If that is so, clearly we will bring pricing down for issuers and investors will not be worse off, which I think is a win-win for everybody. So to me government involvement is key. I think it will happen but it will be gradual and lead to a very efficient outcome. The market dialogue about who should pay the bill etc was for 2014 and previous years.
Everybody has now realised that the market has spoken. You might have better execution and a broader investor base but I do not foresee, without further government support, that bonds will trade 5bp, 10bp, 25bp through just because they are labelled green.