Monday, 10 December 2018

IFR Green Bonds Roundtable 2016: Part 2

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IFR: Very fair points, Ulrik, but that will take time, as you suggested. But in the realm of funding Realpolitik in a volatile 2016, Mirko, where does the green bond agenda go?


Mirko Gerhold, Commerzbank: Through experience, volatile markets have never been supportive of new product developments. From that perspective, volatility is not ideal for the further development of the green bond market. From a credit perspective, we have been seeing a lot of activity from SSA issuers and less from lower-rated and in particular non-financial corporate issuers in the green bond market.

While issuance activity at the moment is biased towards SSA issuers and lower-spread bank issuers, the investor base is not. In SSA transactions we are seeing typical rates investors but we also see credit investors investing in SSA issues for their liquidity portfolios. But the typical buy-and-hold credit investor is also looking for spread so it would be good for the market if we saw some diversification into the corporate sector, which is much more dependent on market developments and the level of volatility than the highly rated most able SSA issuers.

On the other hand, at the moment we are in a situation where spread levels between asset classes and ratings are still compressed. If we see further decompression – which we typically see in a widening environment – there may also be more room for green bond transactions to tighten compared to the non-green secondary curve of a particular issuer. So from that perspective you can also see some sort of positive effect if we see some further decompression of spreads.


Ulrik Ross, HSBC: We also need to take into account the barrier to entry vis-à-vis cost efficiency. We need cost efficiency to eliminate the barrier to entry or to have the right balance between the workload that issuers have to undertake to issue a green bond, and pricing. There is more work implied for issuers to issue green bonds, so if it is price efficient more issuers will come to the market.

There is no shortage of capital to engage into the bond market and especially the green bond market. We have plenty of capital from normal investors and from these new sophisticated funds that are driving the political sustainable agenda. So for me we have to think more about what is blocking issuers and how to motivate that process to make the market grow. That is the real challenge we face in 2016.


IFR: Can you address that question, Philip? To Ulrik’s latter point, why haven’t we seen more industrial issuance? Any company will tell you they have green initiatives but it hasn’t translated into primary green bond issuance this year.


Philip Brown, Citi: I think it is coming. Issuers are going to be driven by demand from investors for the product. We have seen some industrial corporates come to the market; we saw Unilever issue the first sterling corporate green bond in 2014. Unilever is a cash-rich, high-velocity consumer goods company. They are a long way from the energy sector.

Demand for Unilever bonds way exceeds supply and it is interesting that on this rare occasion for them to come to the sterling market they chose to do so in the form of a green bond. Sustainability is central to the corporate strategy of Unilever, not only the treasury but the company as a whole.

What Magnus was saying about Gothenburg is interesting: the dividends that accrue to issuers of green bonds go beyond the specific financing itself. It appeals to the broader constituencies of the issuer. I think the political leadership of the city can see that telling their constituents that they care about the environment and are positively investing in the environment is a vote-winning strategy.

So I think the dividends accrue beyond just financing costs, but I also feel that the growth of investor interest in the sector has exceeded the supply of issuance in 2015. We have seen that recent issuance of green bonds has been heavily over-subscribed. We have also seen a number of financial institution green bonds where the new-issue premium that the issuer has had to pay has been significantly less than they would have done with a non-green bond.

So it seems to me that just the demand and supply equation is going to drive pricing in favour of green bonds more quickly than we might suppose. We still need more issuance but I think it is coming.

At COP21 we had 176 countries responsible for 95% of the world’s greenhouse gas emissions saying they had a plan. I think it is going to be increasingly apparent that issuers recognise that it is going to be important to align their corporate sustainability strategies and be seen to be contributing to this plan.

We see how populations are mobilising: consumers want to see climate-friendly actions being taken. What we are seeing is that for every type of issuer, environmental issues matter. So in 2016, I think we are going to see continued growth.

In 2015, we moved a long way from just the public sector caring about this. We have seen emerging market issuance; we have seen a number of issues now come out of India and China. We have seen asset-backed securities. We have seen corporate securities. We don’t need to be too concerned, it is very clear that this train has left the station. It has a long way to run but people are going to get on board.


IFR: The train may have left the station and the direction of travel may be clear but it’s moving very slowly. So I ask again: where are all the industrial companies today? If there is investor demand and they can get good execution and can pay a lower new-issue premium, isn’t that a slam-dunk for green bonds?


Joop Hessels, ABN AMRO: If you look at the individual figures, banks and corporates together now issue more than the SSA sector so from that perspective, there has been tremendous growth in the market. The second point is that a lot of issuers are looking internally at [potential] sustainable financing [options] or looking to set up criteria for measuring their sustainable assets.

But it takes time and a bit of work. It is also a very positive way of looking at your own organisation and developing a framework, which then also helps the business. So I have great expectations to see that percentage increase even more in 2016 and I think there are a lot of opportunities there.

Another thing to add is many corporate funding sources are linked to banks in many cases. Also, some issuers only come to the market every two years or so for smaller than benchmark size. We have seen some non-benchmark trades in 2015; this is an interesting development because it opens up the market for a large group of corporate issuers who don’t have a US$500m funding requirement.


Bodo Winkler, Berlin Hyp: There has been a lot of talk about big corporates coming to the green bond market but I think what has been most apparent in previous years has been that one other group has been almost completely missing from this market: financial institutions.

We witnessed a bit of a turning point in this regard in 2015 as we saw the first green covered bond and quite an increase in issuance of senior unsecured bonds. What all of that issuance had in common – be it in the first half like ABN or Belin Hyp or in the second half with ING or SocGen – was all the deals went extremely well. That was noted by many other participants from the banking sector.

We are asked by so many competitors: “how exactly did you do it?”; “what do I have to do to set up the framework?”; “can you help me with how to get hold of the assets I already have in the book?”; “how can I earmark them?” There is a lot going on especially in that sector and I think the years where financial institutions will use their green assets are yet to come.


Philip Brown, Citi: We have become very used to the idea of stress tests for the banking industry and I think developments we’ve seen in the financial markets in 2015 just indicate to us that an increasing number of equity investors are going to be looking at the climate vulnerability of listed companies. It is going to become a regular and important component of any kind of investment analysis.

And so just as the public sector has wanted to grandstand around the good work it is doing with regard to climate, I think corporations will also want to highlight the positive work they are doing with regard to sustainability because it is not only going to appeal to bondholders, it is also going to be important to their shareholders.


Aldo Romani, EIB: In certain areas of green bond issuance, marginal costs are diminishing rapidly. The experience of issuers like us is now turning into experience, for example, for auditors. In 2015, we asked our auditors to audit the internal tracking methods around the allocation of proceeds. This is knowledge that can be transmitted to clients in different issuer segments.

I would also highlight the importance of the increasing degree of clarity as to what is actually expected to be delivered. If you do not exactly know the association between what is required in terms of reporting and what you are supposed to do, you have a natural barrier. But if SSA issuers define the platform that clarifies a common stance on this subject, then others have the opportunity to take that as a reference and work on their own elaboration, which by necessity has to be different because an SSA issuer is not a corporate issuer.

ESG rating agencies also have a role to play because they are becoming more and more familiar with what SSA issuers, for example, are doing and they are in a good position thanks to their knowledge of corporates to propose as part of their advisory services what corporates need to do.

I recently gave a presentation to a bank that had issued a green bond and that bank is developing financial institution reporting methodologies. So this a gradual incremental process that will create more certainty around these issues and facilitate the entry of corporate issuers into this market because attention to environmental aspects is growing.


IFR: In terms of the investor aspect to all of this, Magnus did you see a discernible difference between the investors who bought your green bonds versus your non-green bonds? From an investor relations perspective, did you engage more with pools of green money? What kind of questions were you getting from those investors versus traditional bond investors?


Magnus Borelius, City of Gothenburg: We certainly broadened our investor base. We saw investors who never bought our ordinary bonds buy our green bond. One big difference is that [green bond investors] are public with it, which means they are putting huge confidence in our ability to deliver what we actually said we would because their branding is tied into it. That never happened before.

When they say: “we have bought the City of Gothenburg’s green bond,” that means we have to deliver. With an ordinary bond we just have to return the funds at maturity; they trade and that’s it. But here you have a different kind of relationship. And the difference lies also in the fact that I can’t have investor relations meetings with investors alone or with my treasury team. I need to bring in the sustainability department to be sure of answering all of the questions.

It is not the treasury that should be experts on environmental questions. It is not the finance guys who should be talking about what is sustainable and what is not sustainable. We need to take care of the finances but bring in our sustainability colleagues and let them answer relevant questions. That was a mistake we made at the beginning because we tried to be the experts on everything before we really started to work together.


IFR: Charles, do Magnus’s experiences chime with you with regard to your interaction with sustainable investors?


Charles Smith, EBRD: Yes, the interest was a lot more focused. And that is one of the best things around green bonds; they give us an opportunity to present our green credentials. We are very fortunate in the sense that we have a lot of resources on the environmental side: we have an environmental department and colleagues who are very happy to contribute in a very pragmatic way and engage with investors.

Maybe linking up to what Aldo has been saying, we have seen a bit of a shift in thinking around the use of proceeds element. A green bond is a use-of-proceeds bond so it’s about understanding how we originate, how we do the due diligence, how we engage with the client, when we employ environmental consultants and, when we have a project up and running, how we do the monitoring and how we deal with unexpected situations that inevitably arise.

The focus now is shifting towards impact and that is obviously a hot topic. It is something we enjoy talking about and it is the reason we do the green projects in the first place. However, it is further removed in the sense that we have control of the use of proceeds, but when we talk about impacts, these are obviously estimates. For impacts we are looking into the future and there are often differences in methodologies and assumptions. But that is where the main focus is right now.


IFR: Justin, some of the issues that have hit the market in 2015 have come with second opinions. Do you always look for a second opinion? If so why?


Justin Eeles, Affirmative Asset Management: The benefit of the second opinion is transparency and the important thing about use-of-proceeds bonds is the transparency element. Look at how the equity market has developed in terms of corporate governance over the past decade or so; it hasn’t really happened from a bond investor’s perspective in quite the same way. I see growth in use-of-proceeds bonds as analogous to a growing concentration on governance on the fixed-income side because all of a sudden you are finding about how these proceeds are being used.

Rather than just lending someone some money that they will hopefully pay back in however many years’ time, in the case of green bonds you are lending someone some money to do something particular with it. The second opinion is useful in that respect. You don’t always accept it at face value you want to understand why the second opinion has been made, in the same way that you don’t necessarily accept a credit rating agency’s view about the credit.

You want to do some work yourself. So from an investor’s perspective you are doing due diligence and the second opinion is an element of that due diligence. The more information available, hopefully the better informed you will be.


IFR: Ulrik, why haven’t we seen a raft of green sovereign bonds? Wouldn’t a sovereign bond set the market alight and draw attention to it?


Ulrik Ross, HSBC: First and foremost I think it will happen in 2016. We are having more dialogues with sovereigns now than ever before, so clearly it is an area that is opening up. I think one of the reasons for their reluctance is the lack of a clear framework for what constitutes green bonds (taxonomy), whereas for the private sector and the frequent borrower space it is a more natural fit to their mission statement and their need for investor diversification.

Beyond clarity, the sovereign space has also been fragmented between ministries. Now that we are getting there on regulation and framework, I do believe we will start to see political involvement in issuance. There has been green RMB and Sukuk issuance so I would not be surprised if the market saw green sovereign bonds as the next iteration in various forms.

Will that draw attention to the market? Will it be helpful for politicians to mobilise around regulation and subsidy? Absolutely. Fellow panellists have talked today about how it has transformed their processes and linked the organisation internally. Within HSBC too, the connectivity, the processing and the streamlining of how we act internally around sustainability was enhanced significantly by doing our green bond in November 2015. And it is driving us forward in the process even more than we probably would have done without it.


IFR: Philip, beyond direct action by sovereigns in the primary green bond market, could or should government subsidies be part of the broader solution, for example around renewable energy investments?


Philip Brown, Citi: We published a research document called ‘Energy Darwinism’ about why a low-carbon economy doesn’t have to cost the earth. We are seeing dramatic shifts in the cost curves of renewable energies and we would argue that solar technology, which has developed so quickly, is already standing on its own feet. We have many emerging market solar projects that are looking to finance themselves without any kind of public-sector subsidies. I think the renewable energy space is already moving very quickly without government subsidy.

There are interesting things happening in the world with the oil price below US$40 a barrel. That is surely bigger than any government incentive for the oil majors to start investing in renewable energy technologies. In sub-Saharan Africa, where something like 60%-70% of the population lacks access to electricity, we are not going to see electricity grids criss-crossing the whole of Africa. The name of the game in the developed world is about energy efficiency and in the developing world it is about the development of renewable energy, which is happening already without that subsidy.


Ulrik Ross, HSBC: But we can’t discuss energy efficiency without discussing, regulation, and subsidy and carbon prices.


Philip Brown, Citi: The OECD came out with a report in July (“Aligning Policies for a Low-carbon Economy”) which discussed policy misalignments and the amount of government subsidies in the emerging world around the development of fossil fuels. In the developing world, we arguably have negative carbon pricing. The OECD also estimated that government subsidies on company cars, for example, amounts to something like US$30bn a year so I think there are many initiatives that we need governments to act on. The subsidisation of wind farms or solar in the UK is not significant in the overall context of where we are going.


IFR: I wanted to pick up on another aspect of the green bond story, which is about the level of retail investor engagement and how that can be mobilised through the bond market.


Joop Hessels, ABN AMRO: To a large extent, retail interest is dependent on the denominations of transactions and the issuance timeframe. If you want to have real retail-targeted transactions, you probably have the book open for a week or so while most bond execution is done within a day. But obviously you see private banks buying for their own portfolios and they might put them in the mandates of their retail clients depending on the profile.

Where you probably see a bit of a disconnect is in the level of interest rates retail investors would like to see. You need at the very least to get over the hurdle of internal savings accounts and interest rates. In combination with the risk profile, that makes it a bit more difficult but you will see some activity there.


Ulrik Ross, HSBC: With rising interest rates, there is a high likelihood for the retail market to engage with bonds.


Philip Brown, Citi: The vast majority of retail wealth is managed institutionally and it is this recognition that in order to attract that retail wealth to your institutional funds you need to have an ethical product. Justin has recognised at Affirmative that the next generation is going to care far more about the climate than the previous generations have done. Having a sustainable, green product is going to be an essential component of attracting retail money and indeed institutional money for all fund managers in the future.


Justin Eeles, Affirmative Asset Management: It comes back to how you encourage more issuers. Part of it is education: yes there are costs involved initially but a lot of the reporting is presumably being done anyway and a lot of the task lies in formatting your reporting and putting it within a structure. But beyond the initial costs, there are clear benefits.

Having an institutional manager talking to the asset owners, the man on the street whose pension money it is, and educating them about the types of products they buy should be beneficial both for the end-investor in terms of understanding where their money is being invested, and the asset manager in terms of attracting investments.

There are also benefits for issuers in terms of issuing this type of bond because hopefully it is going to make their businesses more sustainable around, for example, energy efficiency, and with potentially higher financial returns over the medium term. That education vis-à-vis potential issuers will encourage the market.


IFR: Does green bond indexation have a role of play, for example, in the construction of green bond ETFs and such-like?


Mirko Gerhold, Commerzbank: We are seeing some developments there but on the other hand the universe of available green bonds is still not big enough for creating large or even more diverse indices. If you take a closer look at the green bond indices, the individual underlying bonds are typically very different. So it is a very heterogeneous group and this is normal because the market is still in its early stages and it will take time to develop further. But it will in line with increasing issuance activity.


Philip Brown, Citi: It could be interesting to see, within an asset class where there is a reasonable volume of issuance out there such as SSA, a supranational green index and then observe whether it outperformed the sector as a whole. But to throw all issuers from Industrial Development Bank of India to the World Bank into a single index would be a peculiar investment strategy.


Bodo Winkler, Berlin Hyp: To be honest, at this stage, even if you took green SSA bonds and put them together in an index, this is still such a tiny market. Even the biggest group – SSA – is so small in green issuance compared with outstanding overall SSA issuance. You might as well just take single green bonds and compare their performance with the brown bonds of the same issuer.

Coming back to indices, what has to happen first is for the green bond market to grow along with its different segments. And then something like ETFs might emerge and attract retail investors. But I think your question was linked to direct retail investment in green bonds. For the time being, it is more geared to indirect investment via banks or funds.


Aldo Romani, EIB: There is still a lot of uncertainty with regard to the parameters of a common definition, and clarifying in particular what “green” is in official terms. An additional dimension of possible public intervention is the establishment of shared taxonomies for the clarification and comparability of assessment standards.

So which are the areas that contribute most to the policy goals that have been established? How do you classify and measure them? If the market – and not just the green bond market but the environmental finance industry too – is not able by itself to produce the kinds of agreements [required], there will need to be some simplification or some benchmark introduced by the public sector. This would be an enormous contribution.

The development of capacity in the assurance industry, for example, which is relevant in creating the trust which will foster market development, is linked to the establishment of standards against which to perform that assurance function.

So it is also a question of providing support subsidies. At the same time, there needs to be some intelligence input; decisions made at public level with regard to what everybody should take as common language and about which there cannot be any uncertainty. At that very moment, you get simplification that enables everybody to perform, adopt the concept and to sell it.

Distribution to retail is very much linked to the willingness of banks to distribute certain products. So what kind of products do they distribute? First of all, their own funding instruments, so you need to have the adoption of that concept with financial institutions. Financial institutions are an essential transmission chain in terms of advisory services for corporates that maybe can also distribute through retail networks. And so it is a spiral that still needs to develop; this knowledge or this reference point is not there yet.


IFR: But who should make that decision though? Whose responsibility is it?


Aldo Romani, EIB: Well public authorities, maybe the European Union acting in a co-ordinating manner. But there is a conundrum here. This market cannot be suffocated by regulation so you cannot have a negative approach to the provision of those forms of support.

You need to do this proactively so everybody can continue to issue green bonds around the key components of transparency and accountability, which permit people to make sure you do what you say.

This can also be done “below the line” because there will be investors willing to buy green bonds that are not as green by reference to this official definition, with forms of public support helping the market to develop in all those areas which are dear to the public sector.

The public sector can’t just define objectives in terms of greenhouse gas emission reductions. It also has to provide the instruments by which the whole system can get traction. The capital markets, via green bonds, can provide incentivisation for and act as an anchor in this process. You need to inject trust into the whole system and really this has to start with the basics.



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