Nick Herbert: Welcome everyone to IFR’s Green Financing Roundtable.
Global Green bond issuance hit a record US$155.5bn in 2017 and there was also record issuance in the first quarter of this year. Estimates for certified Green bond issuance for the whole of 2018 range between US$250bn and US$300bn, yet that’s still only a small percentage of the US$100trn-plus bond market. Do you think we’ve reached a stage in the maturity of the market where issuance is likely to balloon to the levels outlined by [UN climate change chief] Christiana Figueres?
Nicholas Pfaff: I know there’s a lot of debate and I know that some of the other participants in the market are very focused on record numbers every year, but I’m not that focused on market size. Undoubtedly, it’s important that the market reaches a significant size, so that it’s liquid and so that issuers can enter into it with ease, but I think we have already met a certain number of key benchmarks - US$150bn of issuance last year was very important. This year, we seem to be on track for something similar or possibly larger. Perhaps less known, though, is that we’ve just reached US$400bn of outstanding in the market. These are all significant numbers.
Now, comparing these figures to total bond issuance or total outstanding I don’t think is particularly relevant. That comparison reflects the idea that, in some way, all of the bond markets should become green. I don’t think that’s necessarily true or necessarily something we’d particularly want. The idea that all bonds should become Green bonds, or use of proceeds bonds with a focused aim in terms of what they’re going to achieve, is not appropriate for necessarily all forms of finance. Having flexible, general use of proceeds bonds is essential.
If we look at it slightly differently and say, “Well, what is the appropriate size for the Green bond market?”, the best numbers that I am aware of is a 2016 study that was done by the Organisation for Economic Co-operation and Development (OECD). If you look at the numbers it came up with, which were essentially related to the 2°C climate change scenario and how much the bond market should contribute to its financing for 2015 – 2020 for example, then with US$150bn of issuance last year, we’re actually exceeding the target of the OECD study.
I think we also talk too much about size in relation to what may be the real importance of the Green bond market. I would argue that it is the overall effect that the market has in making green investible. I think what’s really striking about what has happened in the Green bond market is we’ve managed to simplify the debate around what is green and come up with high-level categories that also allow policymakers to think about green, and how investing in green can address climate change in a way that is practical. If you think about the years and decades of debate we’ve had about climate change, we’ve had about green, what’s really interesting is how the Green bond market has succeeded in making it real.
The other thing that I think is very important is the way that the Green bond market is now cross-fertilising. Earlier this year, the Loan Market Association (LMA), the Asia-Pacific Loan Market Association (APLMA) and ourselves at ICMA brought out the Green Loan Principles. There has been a big debate about how you bring bank lending into play and while not everything that is relevant to green bonds is transferrable, a lot of it actually is, particularly everything around definitions of green, around reporting, around impact. That is now happening in a very practical way. It’s not only happening in the geographies you would expect - in Europe and in Asia, but also in the US. I was in the US just two weeks ago and I was very pleased to see that there are ongoing initiatives in the US market around green lending. That’s a long answer to the question, but I wanted to provide some perspective.
Jacob Michaelsen: I think market size is clearly something that everyone is focused on, given that it is, perhaps, the most tangible measure of success in the Green bond market.
In the Nordic region, we had close to a 70% increase in Green bond issuance year-on-year in 2017 and, globally, I think it was more like 30%-40%. Bearing in mind the quality of Green bond issuance coming to market, expecting similar levels of supply, or even higher levels of supply, is perhaps not the right path.
With regards to the relative size of the Green bond market, I think that’s a little bit of a different take. If you look at particular markets, Green bonds have averaged 5%-7% of the total size of each market in the last couple of years. But what’s really interesting is that actually in Sweden, this year, we’ve seen that the level in Q1 has increased to 14%. It certainly feels like every other deal that comes to the market in Swedish kronor is coming with a Green bond label. We’re seeing a very diverse set of issuers in terms of metal and mining companies, real estate companies and so on.
Nick Herbert: There always seems to be a complaint that there is more demand than supply in the market. How are investors and issuers approaching the market and has there been a step-change in attitude?
Jacob Michaelsen: I think there has definitely been a step-change in attitude. I clearly see the development of the market - particularly the Nordic market, trending towards Green bond market 2.0 status. I say that in terms of the use of the format by a wider range of issuers – that is, the relative share of the SSA issuers has fallen even though the absolute level has remained the same. That is very encouraging. I think that ties in with the investor question. We’re clearly seeing that investors are focused on sustainability more broadly and also at issuers in a non-labelled format as well.
It’s interesting. I spoke to a Swedish investor a few weeks ago where the portfolio manager said that when their Green bond fund was launched everyone asked them, “What are Green bonds?” Now everyone is saying, “We want to do Green bonds as well”. Interestingly, that investor is now at the point where they are looking further ahead. They are not just looking at Green bonds, but rather saying, “Okay, Green bonds provide the platform that we can use to talk about other issues, such as broader environmental considerations, social considerations, water considerations etc.” I think that is a good reflection of where the market is going.
Nick Herbert: Given the demand/supply dynamic, has that impacted pricing and, if so, is it something that’s good for the market’s development?
Johan Fredriksson: It’s hard to measure the pricing factor in this because I would never issue a Green bond and a regular bond at the same time. We see some pricing difference in bank financing but pricing is not always the motivation behind issuing bonds: we get better tenors and access to a wider investor base when we go into the bond market. Perhaps if we’re able to meet specific investor demands by issuing long-dated private placements, for instance, we can add some extra value to the bonds. But if that is worth 2bp, 5bp or 1bp, I really can’t tell.
The early movers in the market say they might get as much as 5bp on a Green bond in primary, but that’s not the case in the broad market. In secondary, there’s maybe more evidence of an impact, particularly in Sweden where the demand for Green bonds is higher than for a regular bond. I think there is evidence that Green bonds might price better. But for us as an issuer, it’s not really an issue; we post the same levels. You’ll always find some Green bond investors willing to take new levels or investors that will place the first bid but you have to remember that they are part of the overall investor base. Green investors are really important but we’re not looking at the market purely from a pricing perspective.
Nick Herbert: There is a point when the investors will push back in any case. EIB bonds trade a bit tighter in secondary. Have they found the right level for the green premium?
Irene Sanchez: Yes, indeed, EIB Green bonds are trading a bit tighter in secondary. That’s partially due to the existence of greater investor demand than supply for our Green bonds. This strong demand also provides additional resilience to the bookbuilding process, but nonetheless, we are not focused on achieving a certain price differential target when it comes to pricing our Green bonds versus our conventional bonds because, in essence, they are the same financial security.
However, we are focused on other qualitative aspects required to build a more robust Green bond market. In our role as a multilateral development bank, we have to lead the way, by not only providing supply, but by also facilitating certain “best practices” in an effort to encourage other issuers to follow. In this respect, we work very closely with other institutions to bring transparency in terms of definition of eligibility criteria, standards, reporting and continued development of innovative products. These aspects are much more important to us and can in turn contribute to the higher investor demand and create some price tightening.
Nick Herbert: If we are to see more supply, is it right to focus on specific issuance levels? I mean, is there any correlation between issuance and impact?
Michael Wilkins: It’s an interesting question. We also need to focus on the broader market and not just Green-labelled bonds because, as far as we’re concerned at S&P Global Ratings, it’s more the environmental contribution of any financing rather than just the label that really matters in terms of scaling up and meeting the transition to a low-carbon economy. But in terms of impact, yes, I think it is very important to look at both sides of the equation: supply and impact.
We do need to grow the market but in a disciplined way; we need to avoid the risk of ‘green-washing’. The best way to do this is by following the Green Bond Principles and making sure there is proper reporting and disclosure in place so that everybody understands exactly where the proceeds have been allocated and, through annual reporting, that the projects are indeed making a contribution. If you follow the four basic pillars of the Green Bond Principles, I think that gives investors the reassurance they’re looking for.
The other side of the equation is impact. When we launched the Green Evaluation a year ago, we wanted to make sure that we covered the impact side as well: looking at the contribution the financing is making relative to other financings, whether it’s on carbon, water or waste. Whatever the environmental key performance indicator, it needs to be ranked and measured so that investors can see that if they buy one Green bond over another, they can evaluate which one is actually making the more significant contribution. That gives them the knowledge to price a bond accordingly.
We’ve talked about pricing in a binary way: should it be cheaper, or shouldn’t it be cheaper? Instead, the question should be, “How much cheaper should it be for the issuer to issue a Green bond relative to non-green? What kind of discount should they get?”
You’re never going to get an investor to say that they’re willing to pay up for green, because that’s like turkeys voting for Christmas. They just don’t want to do it. It doesn’t make sense. But the reality is that they do pay up because of the scarcity of supply relative to demand. So, in that kind of situation, it is important to move into a more mature state of affairs, one that requires an understanding of pricing according to the relative value of greenness.
The value of green needs to be discovered. It needs to be reflected in the pricing, just as the quality of credit is reflected in pricing. You pay more for a better credit and less for a worse credit. In theory, you should pay more for a higher value of green, or a greener issue, than a less green issue. That level of maturity in the market is now starting to develop, but it is still early days. It requires benchmarks, it requires transparency and it requires more sophistication.
Jacob Michaelsen: There are a number of different perspectives that are important. First and foremost is the context of the discussion because it’s often the case that the discussion becomes a basis point discussion, where it’s about discovering the Green bond premium or discount. It’s certainly relevant, but it needs to come with a sufficient disclaimer.
At a recent panel discussion one of the investors said that we can’t risk going too far down the path of Green bonds pricing tighter than regular bonds because we run the risk of cutting off a large part of the investor base. If we are truly to develop a global Green bond market, we can’t risk that happening. It’s important to look at pricing in the right context.
I think there the discussion also becomes one of a specific issue versus the borrower’s entire curve where we would be talking about a green halo effect. We need to look at a much broader perspective where there should be consideration for the overall credit risk of the borrower due to its focus and performance on ESG matters. I think it’s a discussion that’s very relevant to have, but it’s important to have it in a nuanced context.
With that said, we’re clearly seeing pricing differences for the most fundamental reason of simple supply/demand imbalances. I think that is best reflected when you look at different currencies.
The Nordic Investment Bank, for instance, has issued in dollars, euros and Swedish kronor in green format. Their bonds provide a good reflection as to the depth of the investor base in each of these markets. There is no real premium from issuing in dollars, whereas in euros you can see that investors have more of a focus on Green bonds. But the real significant price movements are in the Swedish kronor space. I think Johan can testify to that. There’s a certain level of demand and ‘stickiness’ with Swedish investors when it comes to green.
The “greenium” is certainly a relevant topic. But it’s not a one-size-fits-all discussion.
Nick Herbert: How is relative greenness approached in your bond ratings assessments, Jaspreet?
Jaspreet Duhra: It’s a good question. We’re often approached at the stage where a company is thinking about issuing a Green bond and they will say to us, or their DCM team will say to us, “Do you consider this use of proceeds to be green enough, to be sustainable enough?” Often at that point we will say, “Well, no.” About half of the conversations will end there. Then, inevitably, three months down the line, you’ll see that issuance has come out and someone else has given an external opinion to that use of proceeds. So, there are definitely different definitions of green and greenness.
I think the DCM teams work a lot with the different external providers and have a good overview of the levels of greenness that different external verifiers apply. This is where it’s really important that we have taxonomies and guidance to enable the market to take a view. We have our own opinion. We look at international benchmarks and international best practice, but that might not necessarily align with somebody else’s opinion. This is where a taxonomy is really important.
Nick Herbert: Is that a risk that you foresee as the market grows? Are there going to be problems with the different approaches taken by third-party verifiers?
Jaspreet Duhra: Yes, I think you get that now. I don’t think the market needs to grow for it to be an issue, because I think at the moment you get a real variety of different types of external review. So, some reviewers will look just at the climate impact or the environmental impact and others will also look at the social impact. Some providers will look at the issuer and others won’t look at the issuer. There are already lots of different ways that you can do verification and I think you already get different qualities. As the market grows, inevitably you get more players coming into the market, so you’ll get an even wider disparity. I think, generally, the more responsible investors have a good awareness of which are the better third-party reviewers.
Nick Herbert: That’s all well and good for the more sophisticated investors but it’s all very confusing for everyone else. How do you maintain the credibility of the market as it grows?
Tallat Hussain: The credibility of the secondary opinion providers and other sorts of verifiers is becoming a really important concern for the market. If the greenness of an asset or investment is in the eye of the investor, then finding an exact definition that suits every sector, project, policy or outcome is not the main route to enhancing credibility in the market. Without putting too fine a point on it, there needs to be some accountability for opinion providers and other verifiers in the life of a Green bond. Requirements for certification or verification standards for those who are determining the colour of green will definitely add to the level of integrity that the market is looking for.
One of the challenges with markets that develop as quickly as the Green bond market is the difficulty in reigning it in while at the same time giving it the flexibility to grow.
We see indications, for instance in the US, where there are disclosure requirements under SEC rules that seem to show a connection between regulation and the fact that there are fewer corporate issuers. Issuers may genuinely be concerned about what will be disclosed whereas where you don’t have the same parameters around disclosure, you have a freer market.
It all comes down to the integrity of the product. It doesn’t matter what colour green the product or project is because the various opinion providers are looking at different aspects in making their determination. This in turn comes down to integrity of the green label, the opinion, verification or certification. Accountability is the key for this.
When we look at the Green Bond Principles, the focus is usually on the use of proceeds. That is the first determinant, the first benchmark of green. After that, the focus turns to keeping it green by ring-fencing the proceeds, managing the proceeds and then reporting on the use of proceeds. From my perspective, the reporting is the most important part of the principles. In my experience with project finance, reporting on implementation and compliance is probably more important than actually imposing standards, such as the Equator Principles, in the first place.
Moreover, having the initial secondary opinion provider confirm what it confirms to be green in the first place should be distanced at the reporting end, where there should be another independent opinion after the first year of the green instrument, confirming the use or impact of the bond proceeds, including the progress toward the initial commitment. Having the annual review conducted by another verifier or third-party reviewer would add a level of integrity and avoid any conflict of interest, for example, where the initial secondary opinion provider is pre-contracted to provide the first audit or annual update. This also adds a level of integrity that the market is looking for. I think the market (and the service providers) can bear that.
Nicholas Pfaff: We are doing a lot of work on the question of external reviewers and market integrity and we’ve reached out to all the external reviewers, which is a very diverse group: second opinion providers; ratings agencies; certifiers, etc. We have an ongoing dialogue with all those market participants and we’re focusing on questions of what exactly they do. What is their business model? What is the nature of potential conflicts?
We are hoping that at this year’s Green Bond Principles AGM in Hong Kong we will be able to report back on our progress and make some announcements. We’re not quite there yet - we’re right in the middle of these discussions. But, as I say, this is a topic of significant concern and we’re having a really good dialogue with the external reviewers on this.
Nick Herbert: We have opinions on the use of proceeds but the actual impact seems to be based on a lot of best wishes. I know there are some moves on reporting on impact but, in essence, isn’t the best way to monitor the greenness of any use of proceeds from a bond an assessment of the greenness of the issuer itself?
Jaspreet Duhra: Yes, absolutely. I think it’s a really, really important part of the process. As I said for the first point, we’ll look at the use of proceeds, but the other thing we’ll always look at is the sustainability profile of the issuer - we have ratings of 6,000 issuers as part of the ESG research that we do for investors. We’ll look to see what rating we’ve given the issuer. If it’s not our prime standard, which is where we think the issuer is doing a good job in terms of managing its sustainability impacts and challenges, then at that point we’ll probably again be reluctant to go forward with an opinion on the overall issuance.
Having a Green bond referenced to one or two use of proceeds is all well and good, but if 95% of your business is not working towards sustainability or sustainable development, it might actually be taking away from the benefits of your one or two Green bond projects. That’s not something that we want to be endorsing or putting our label on. I think it’s really important.
There is some issuance, for instance the Polish government’s bond, where the borrower’s track record on climate change and environmental issues is poor, both nationally and internationally. It was still able to issue a Green-labelled bond, but some investors understandably had a problem with it.
You get it on the corporate side as well, where oil and gas companies are issuing Green bonds. Again, we would probably stay away from those types of deals because we don’t think that they are working towards the kind of sustainable development we’d like to see.
Nick Herbert: I know that’s a view that many in the Green bond market don’t agree with.
Julie Becker: Well, I’m very sorry because I, indeed, do not share this point of view about the profile of the issuer of Green bonds. If we want to reach the Paris objectives, we clearly have to engage in a transition process. It won’t be a move from brown to green from one day to another, and that means we have to promote a step in the right direction - even from oil and gas companies or from a state. We need to support their attempts to move towards greener activities and to help develop a sustainable economy and a sustainable finance market.
As an exchange, our role is to promote transparency and to provide all the information investors need to make informed investment decisions. But clearly, after the investor has all the information he or she needs, a choice still needs to be made. The objective is to make everything transparent, to give investors maximum information they need to take an informed decision. That needs clear information; transparent, credible, comparable information. But it’s up to the investor to choose whether the Green bond issuer should have on top a sustainable profile acceptable to him or her.
Nick Herbert: We should be supporting the transition but how quickly, and to what extent, should we support it? The Poland deal, for instance; some people have expressed disappointment that their plans to increase the proportion of renewable energy is not ambitious enough.
Julie Becker: Yes, but I think it’s better to be not ambitious enough than not ambitious at all.
Tallat Hussain: I’ve been an environmental lawyer for 25 years so it’s not just that I have become pragmatic, but the reality is that when a market is starting, there is a need to make sure that flexibility exists within that market. That’s not to underplay environmental and social commitments and requirements, and all of the other aspects of potential bond issuance that we’re talking about in terms of sustainability. Nor is it to condone the turning of a blind eye to greenwashing. A free market makes choices.
Poland needed to start somewhere. There is a starting point for every market, every initiative and the application of policies. Transitioning into a market cannot mean overnight, fully formed regulatory infrastructure, procedures and buy-in. It is an iterative process as markets develop. Take the Middle East as an example; it’s the perfect place to put up solar panels but should we be saying that oil-based economies should not be delving into the renewable space and issuing Green bonds? It’s very Eurocentric to think that only the cleanest of all the European countries, and we’re not even including North America in all of this, should be the ones issuing Green bonds. That could be seen as a way of circumscribing the Green bond market in a prohibitive way, and this may have a knock-on effect for other forms of sustainability finance.
A lack of flexibility could also discourage companies from having the courage to issue Green bonds, yet Green bonds started as an innovation. A pedantic approach may stop sovereigns from having the courage to issue Green bonds for fear that the country’s environmental record or economic base would not be looked upon favourably to warrant or support issuing a Green bond. But this is where the market in a country can start. Sovereigns have the power to set an example and get a market started.
Nicholas Pfaff: The Green bond market was, to some extent, instigated to allow brown issuers to issue Green bonds. It was a case of how to enable transition from the beginning. I think it would be a mistake to go back on that.
Having said that, integrity and credibility in the market are fundamental for its further development. I think it is legitimate as the market develops, as we progress, to focus on the overall business model and focus on wider ESG tracking of the issuers. I think there is a path to that.
Certainly, with the GBP we have been increasingly emphasising the fact that you can’t just have one Green bond and that’s it, job done. The bond has to indicate your path to transition and how you’re looking overall at, not only, environmental risk but social risk as well. Clearly, there is an emphasis on a transition dynamic, which is very important to underline.
Irene Sanchez: First and foremost, a Green bond is a bond with a commitment on its use of proceeds. That’s one of the core pillars of the Green Bond Principles. However, this doesn’t mean that the ESG profile of the issuer is completely irrelevant to a sustainable buyer. For example, it’s important for an investor to judge whether a Green bond issued by an oil company is a one-off transaction or if it actually fits into the strategy of the company to transition to low-carbon operations. Has the company thought about it from a long-term perspective?
These considerations are very relevant to investors and they need to be to be communicated, either through the issuer’s own reporting or through the opinion of external reviewers. One doesn’t exclude the other, but a Green bond is built on transparency and accountability so we need to start from the process, the use of proceeds definition and reporting.
Jacob Michaelsen: I think there are a number of different discussions that are very interesting in their own right. But if you look a little bit further ahead, they’re actually coming together. At the GBP annual general meeting last year, one of the great things brought up there was the focus on strategic alignment - because that’s really the discussion that underlines the question, “Which kind of issuers can issue Green bonds?”
If you look at the Green bond frameworks that are being put together since then, the introductory section has grown longer and longer. There’s no need for this introduction to turn into a 10-page document, but it does illustrate the increased expectations in the market in terms of establishing the strategic foundation of the issuer. It gives the borrower a platform from which to communicate its broader strategic alignment;.
It’s very encouraging to hear about ICMA’s work on external reviewers because, in a time when we’re talking about standardisation and we have the European Commission’s action plan, clearly an area of the market where we can do a lot is within the space of second-party opinion providers or external reviewers. This is partly because there is a great need for it. Although essentially providing the same end-conclusion to the investors the different second-party opinion providers go about it in quite different ways. Also, since none of the major established second-party opinion providers are regulated it makes the discussion more straightforward than some of the others around standardisation in the market today.
Every newcomer’s approach to providing opinions is relevant, but how do we assess these different approaches? Maybe the analysis will result in shades of green or specific ratings, but whatever the outcome, there should be some consistency. If you get alignment, then we can come back to a pricing discussion. That’s when you can really start to find segments within the Green bond space.
If everyone accepts dark, medium and light shading, or an A, B, C rating, whatever it is, and if all the second-party opinion providers can show they are in step, then that means investors can choose the bonds to buy and sell. They can choose how green they want to be. Maybe then we can also see a pricing discussion in terms of the darkest green of issuers verses the lightest of the issuers. It’s tremendously interesting.
Julie Becker: I hear what Jacob is saying but, at the same time, we have to be careful not to kill the Green bond market. Even if the ESG profile of Green bond issuers might be very interesting and should be transparent and visible for investors, it still comes back to the initial question of how to support the development of the market.
What would help the faster development of the market is an improvement in the diversity of issuers. If the market depends on the activity of too few issuers, then there is a major problem with the depth and breadth of the market. We have to make sure that we don’t place too many demands on Green bond issuers so that they are put off from going green and engaging in this market.
From a positive perspective, our exchange has had a number of first-time issuers of Green bonds in the first quarter of 2018. That’s clearly a very positive development.
Nick Herbert: Johan, Vasakronan has recently updated its Green bond framework. At what point does it become prohibitive for an issuer to provide the amount of information required by the market?
Johan Fredriksson: To be fair, it’s not that big a thing for us because we wouldn’t be profitable as a company if we didn’t monitor our energy consumption. We’re doing it anyway, measuring energy consumption and waste. Everything that goes into a building or out from a building costs money, so we’re constantly monitoring it. For us, we already have the type of impact numbers suitable for the Green bond framework. It’s no additional work. We just put together a report saying, “our energy consumption has gone down by this much, water consumption by this much,” and so on. In other businesses, it might be more complicated of course. But for us, it’s a given.
Nick Herbert: So, for you, the collection of relevant data has an economic incentive as well?
Johan Fredriksson: Yes, we have updated our framework because we are getting better at collecting the data and the world is getting better at looking at this aspect of a company’s profile. Our first framework extended to just two pages and essentially consisted of a commitment to emit less carbon and use less energy. Now we have accommodated more elements of our commitment, our overall green and social profile, and the data to support the impact of our efforts. We plan to refresh the framework every four years.
Our first framework was relatively straightforward. As the first corporate issuer of a Green bond in 2013, we had the full attention of the banks, investors and the market. Our goal when we first began this environmental project in 2009 was to halve our energy consumption in 10 years. We managed to do that in eight years.
This time, the framework was a little bit more complex to put together, a bit more complicated and refined. It reflects the increasing sophistication in the market.
Nick Herbert: In terms of impact, potential investors could have looked at you as an issuer as opposed to purely an issuer of a Green bond where proceeds go towards an environmental project?
Johan Fredriksson: Yes.
Nick Herbert: Michael. How does S&P approach the whole issue of greenness? Is it the issuer or the bond?
Michael Wilkins: So far, we’ve focused on the environmental impact as well as the transparency and governance of the transaction. We look at both sides from the perspective of the Green Evaluation. We look at the mitigation aspect – in terms of the contribution that financing is making to reducing carbon emissions or improving pollution controls or better water management, whatever the particular environmental benefit may be. Then we do a relative ranking based on the pre-populated data in our tool.
We come up with a relative ranking and then we link that to the baseline of the country in which the projects are located. For example, if you have a renewable project in Sweden, it’s going to make less of an environmental contribution than if it were being built in China. This is because Sweden already has a decarbonised grid while China is heavily carbon-intensive. You have a relative ranking based on geography as well.
Then we apply a hierarchy approach. Here we give more adjustment upwards for types of technologies that are making a long-term systemic decarbonisation impact like renewables or energy efficiency, as opposed to other types of technologies, where the systemic long-term decarbonisation will be less evident like clean coal or coal to gas.
Where possible, we align the scoring that we have in our Green Evaluation with the 2°C target set in the Paris Agreement.
Our approach is unique. Ultimately, this is going to be – and is – an investor-driven market. Whether we get standardisation among the external reviewers will depend on how the policy and regulatory frameworks develop over time. If we look at what has happened in the credit markets, for example, we’ve seen that credit ratings are used for a number of purposes – one of which is to help banking regulation for capital adequacy purposes. If we move in that direction for green or sustainability in general, will we have policy and regulation that actually has an impact on capital requirements?
I know that’s been mooted by the European Commission. It’s hotly debated whether it’s a good thing or not. All I’m saying is that as we see the Green bond market develop, it will likely be heavily influenced by regulatory guidance.
Tallat Hussain: Having said that certification of players in the market is a good thing, I’m going to be a little bit contrarian about issuances. Recently, we have seen a pure-play green corporate with a very good ESG profile explain why it has successfully issued unlabelled green bonds. The company’s ESG profile has been verified by a reputable secondary opinion provider and the company also has a green rating from a ratings agency that is also considered reputable in the market.
Interestingly, is that although the company is pure green, it is not a labelled Green bond issuer. It has issued “green bonds”, but they aren’t labelled Green bonds. They are designed to align with the Green Bond Principles, but they are not certified against the Green Bond Principles. Some investors would not invest in such a green bond whereas others would. If the investor base seeks to have a labelled Green bond then even if the ESG profile of the company itself is extremely well-rated and also has a reputable second opinion that may not be enough. “How green is my bond” is a determination for investors seeking to invest along the green colour spectrum. As a result, whether certification for Green bonds will play a greater role remains to be seen.
Nick Herbert: Is that a concern to the development of the market? Mandates that say you can only invest in CBI certified bonds?
Tallat Hussain: I think there is an iceberg infographic created by the CBI – there are lots of green bonds below the surface of the labelled Green bond market, the visible labelled Green bond market. The unlabelled green bond market is about two to three times larger than the labelled Green bond market. One has to wonder about the significance of the label. Does an insistence on labelling actually reduce the size of the market? Arguably, just based on the exponential increase in the Green bond market over the past decade, perhaps not, historically, but as Green bonds are now a recognised asset place, this added layer of accountability and transparency, whether in the verification process or the bond itself, may be moving market participants in that direction.
To Nicholas’s point, I don’t know if the size of the market really matters either. But something that is important is the impact on the environment as a result of the market’s development. Ultimately it’s the development of this asset class (Green bonds) that drives more asset classes, things like Green loans. Loans, in turn, drive Green securitisations and other financial innovation for sustainability, and it is through this mechanism that “green” becomes part of the nomenclature of absolutely every corporate and financial transaction. In this very short period of time, in this decade of green bonds, I believe Green bonds have actually made a huge difference in addressing environmental issues.
Nick Herbert: Julie, are there any restrictions on what you include in your listing? Effectively, do you have a mandate to reject bonds that aren’t certified?
Julie Becker: No. We impose mandatory entry requirements to be displayed on our green exchange, based on best market practices (ie, GBP’s four components). That’s the reason why we monitor the fulfilment of the commitments made by the Green bond issuers. If they fail to provide us with a post-issuance report, then they will be sanctioned by being withdrawn from the green platform.
But so far, even with a 50% market share of all listed Green bonds on exchanges worldwide, we have not yet had to do that kind of thing. All displayed Green bond issuers on LGX are complying with their commitment to report post-issuance.
Nick Herbert: I think we’ve touched on a few other issues that, perhaps, we can develop. I recently heard a quote that suggested that the market will only really develop when you’ve got regulations, reputation and risk aligned. We’ve gone through a lot of debate and talk lately at the regulatory level - HLEG’s recommendations to the European Commission, the UK Task Force, a paper delivered to the Swedish government. Julie, what do you feel were the most significant features of the proposals put forward to the and the considerations proposed to the EC?
Julie Becker: As we are talking about Green bonds, I’d like to highlight two main points. The first one is the green taxonomy and the taxonomy regulation, which is about to be published very soon. [It was published on May 24]. It is clearly the backbone of all the recommendations and of all our discussions at the roundtable. We asked earlier, “What is really green?” And, further, “How is it green and is it green enough?” We all really need to be speaking the same language about green and about sustainability. Secondly, the taxonomy regulation should remain flexible, to be regularly updated and be adopted through a step-by-step approach. The High-Level Expert Group recommended to focus on climate change mitigation first and only one year later, Q2 2019, on climate change adaptation and other environmental issues.
But let’s focus also on Green bonds and on something that has not been recommended by the High-Level Expert Group but has been published by the EC in its action plan about the amendment of prospectus regulation. It will specify what additional documentation a Green bond issuer would need to provide in the prospectus. This is exactly how it is already done in China, with a green chapter inside the prospectus.
For me, if prospectus regulation is going to be completed as such, it could be a very positive development. On the other hand, it could be argued that increased requirements for documentation could also deter Green bond issuance. We have to realise that once the green nature of the process is embedded into the prospectus, that then it becomes legally binding for the issuer. The implications are very, very important. In my mind, it might actually be appropriate to think about how to lighten requirements of, for instance, an external review, in order to lessen the burden on Green bond issuers and to avoid the risk of killing the market. I say this in the context of the wider capital markets union, where prospectus regulation is being revised to lighten requirements for SMEs in order to foster easier access to capital markets.
It’s very important to find some elements to offset those potential new requirements inside the prospectus regulation. We clearly need to find the right balance and I guess that’s the main challenge for the European Commission.
Irene Sanchez: Delivering a taxonomy on sustainable activities is a key development for capital markets, and one that has been long awaited. It is expected to be a detailed taxonomy, which will disentangle the activities from the objectives the activities serve to, which, until now have been somewhat mixed. This matrix will provide the base for policymakers to define screening criteria and impact metrics against certain thresholds.
Thanks to its intrinsic transparency, the taxonomy is expected to not only facilitate a more-efficient allocation of capital to green projects, but to also help policy makers take decisions regarding the objectives that they may want to tackle to help make the financial system more sustainable.
Nick Herbert: Michael, you mentioned that there is much discussion around the subject of capital requirements.
Michael Wilkins: I think it’s well known in the market that not everybody is fully onboard with the “green supporting factor”, which is the term we hear for the Commission’s proposal to give capital relief to loans and other assets that are designated green. Being green doesn’t necessarily mean that you’re less risky. As a credit ratings agency, we can see both sides of the equation. We do credit ratings that are basically looking at risk and we also look at environmental contribution through the Green Evaluation.
We can see that you could have a very high environmental contribution, say, as a wind project in an emerging market country, but your credit rating could be really low. This might be due to a company being very high risk or due to a very highly leveraged structure in project financing, for instance, or because of the off-take, or whatever it may be that pushes your credit rating right down. You may be very high risk from a credit perspective although you may be making a very high environmental contribution.
We would argue that you need a balanced score card approach as an investor – looking at the variables on which you’re making your decision and taking on a balanced approach depending on the type of risk and your appetite for the environmental contribution being made.
But going back to the green supporting factor, I think the banking community in particular is somewhat troubled by this discussion in terms of the systemic risk contribution that it could make. I don’t think the European Commission is unaware of that, but there seems to be a political push to go down this route. It hasn’t been abandoned yet, but we’ll see what happens. It’s certainly very hotly contested.
Nicholas Pfaff: You’re right, it’s very much in debate. Mike’s point about the potential divergence between environmental performance, environmental risk and credit risk is something we have to bear in mind. In terms of what the EC is trying to achieve, it’s not clear that we actually need to have an explicit green supporting factor to achieve the end we’re aiming for. What I mean by that is, if we have an official recognition by regulators of what is a green asset, green bond, green loan, I would expect there would be a natural ring-fencing and recognition by the market which would favour green assets. The reason being is that, at some point down the road, we are going to have to factor into the prudential system climate risk and stranded assets etc.
I think what we’ll find is that if we’re able to clarify what is green, we don’t necessarily need to lower the capital requirements. If I’m a prudent investor, I’d say, “Well, I know that’s a green asset and I also know that at some point down the road this whole other set of brown and related assets are at risk of becoming problematic”. I’m naturally going to start changing the weighting of my portfolio and my investments towards the green assets. By clearly identifying green assets, we may actually create a self-fulfilling positive investment dynamic.
Tallat Hussain: I know there’s a lot of concern about this. If the market continues to self-regulate as it does around Green bonds and we’ve got secondary opinion providers, taxonomies, the elements of whatever creates transparency in the system, environmental and social governance requirements, etc., then the integrity of the green asset will take care of itself. That will move the market to be more innovative to address green finance with capital requirements as they currently are, appreciating their restrictive nature. What we really should be doing to facilitate green and sustainable investment is encouraging issuers to create products with integrity. Whether regulatory changes are part of the toolkit to develop, promote or strengthen green finance will then be better guided.
Jacob Michaelsen: The discussion is certainly relevant, but it’s very important to look at the time perspective. That’s because, if you have a very short or medium-term outlook then a reduction of capital is interesting, since it will give you the impact that you’re looking for. But, if you are looking for a lasting, long-term approach then you really want to focus on solid market structures that provide the right incentives, rather than subsidies. From discussions I have with issuers, which include both financial issuers and corporates, the main obstacle preventing more issuers coming to market is the lack of certainty around what is green and if they should commit the internal resources to it
In the case of real estate companies, or if you’re a renewable energy company or a utility company, where the discussion is so well-defined through CBI’s own taxonomy, then issuers are confident of the Green bond launch process. But if you’re not within those categories, the discussion is not so clear. There is a large degree of uncertainty holding back a lot of issuers and it’s those issuers we need to cater to.
I think the action plan focused on a green taxonomy is clearly the most tangible and relevant initiative that we’ve seen in the last couple of months to drive the market forward in the long term.
Nick Herbert: Are the regulators doing enough?
Jaspreet Duhra: Well, they’re doing something and I think you see some interesting developments in different regions. In Singapore, they’ve started offering subsidies to issuers of Green bonds to international best practice standards. That’s an interesting initiative. The IFC has a pool of money for emerging market countries, in terms of helping issuances and the kind of documentation that you need. I think there’s a lot you can do to try to stimulate the market.
Based on my experience of talking to issuers, there are questions; questions in terms of what is green, questions around, “How will the market perceive it?” and “Is this going to be a reputational risk for us?” I think the more information and guidance the better. At the same time, I can see how it’s confusing because you have the Green Bond Principles, you have the Climate Bonds Standards, you have the EU regulations, and you’ve got an ISO Green bond standard coming out.
So, where do you go to? The more the guidelines can say, “Well, if you tick the EU standard then you’ve ticked the Green bond standard and you’ve ticked the climate bonds standard”, I think that kind of bringing together of regulation will certainly help. But, yes, I think there is perhaps more that can be done and I think we’re seeing some interesting initiatives that could be used as examples.
Nick Herbert: I’d just like to touch on sovereign bonds. We’ve been expecting great things, or it looked like we were going to get great things following on from France last year and Belgium and Indonesia this year. To some, the flow of sovereign bonds has been a bit disappointing. Is that fair? Why have there been so few major sovereign issuers in the market?
Nicholas Pfaff: I’m less pessimistic than you are on the number of sovereign bonds but I agree, it’s not like there’s been a tsunami of sovereign bonds coming through. There have been some very significant issuers, both from the developed markets - France, Belgium, and then some really interesting emerging market issues like the recent Green sukuk from Indonesia. The market is definitely moving.
Why isn’t there more? I think the obvious answer is that it’s still fairly early days in the development of the Green bond market as a whole. In addition, it’s actually not straightforward for sovereign borrowers to issue use-of-proceeds bonds. If you look at how a sovereign finances itself, having an instrument that is focused on underlying projects is not at all a natural thing for a sovereign to do. There may well be limits to how much and how practical Green bonds are for that category of issuer.
Having said that, when they are issued they can be very useful indeed. They’re useful in the same way that they are for some corporates in terms of clarifying the debate within the issuer as to what they are trying to achieve. They force cooperation in a way that may never have happened before between different ministries. It’s really interesting. You have people who have never talked together before - they’ve never even been in the same room before. So, the sovereign Green bond forces the finance ministry to focus on what the environment ministry is saying. It forces a political decision with accountability. That’s very novel. It makes Green bonds a very powerful instrument.
At the same time, if you talk off the record with some of the debt management agencies you find that there is some reticence to the issue since doing so takes a lot of extra work; it’s not something that debt management offices have traditionally been set up to manage. They’re set up to issue at scale and to monitor and to intervene in the market. There’s a practical aspect.
Looking at the future of this instrument, I think that it would be perhaps most interesting and most useful to see how it rolls out in emerging markets since I think that, in those markets, it does have an additional benefit. The French sovereign or the Swedish sovereign doesn’t need a Green bond to figure out how to go out to the investor community, for example. On the other hand, if you’re an emerging market borrower and you don’t have a great credit profile then, if you issue a Green bond, that gives you access to a different segment of the market; a greater range of investors where there may be greater patience. You also tick a lot of boxes in terms of policy issues.
I expect we’ll see more sovereign Green bonds coming out of emerging markets and that will be a very powerful tool, particularly when EM sovereigns start getting more concerned in the practice of how they align with the Paris Agreement.
Does that mean that the sovereign Green bond market is going to be the largest component of the overall Green bond market? I’m not sure.
Nick Herbert: Johan, would you welcome a sovereign Green bond for benchmarking purposes?
Johan Fredriksson: I don’t think it matters to us - in Sweden, at least. We’re fortunate that the Swedish Green bond market is already largely self-sufficient - we have enough issuers and enough investors. Whether the Swedish government launches a Green bond doesn’t really matter for the Swedish kronor market. Maybe it can save two or three basis points on the government curve. If it did come to the market, it would be for political rather than economic reasons.
We’re also active in the Norwegian market, which is maybe one and a half or two years behind Sweden in its Green bond market development. So, there, it might help to see a sovereign issue in the market.
Nick Herbert: A sovereign bond also sends a good message to a wider audience.
Michael Wilkins: Yes, and I think it’s the Paris Agreement and the Nationally Determined Contributions (NDCs), that are really going to drive sovereign Green bond issuance in the future. I agree with Nicholas in that it’s still early days but, as we move onto the next COP meeting and the one after that, and capital allocation plans start to be hard-coded into sovereign budgets, then that’s where we’re going to see sovereign Green bond issuance really tick up.
I think the other thing that we haven’t really mentioned yet is adaptation financing - making your infrastructure and your urban environments more resilient to the impacts of climate change. These projects are largely financed by the public sector, by municipalities, by local government, by sovereigns and less so by the private sector. That’s not going to change any time soon. It’s still going to be largely a public responsibility to plan for adaptation: building flood defence barriers, strengthening bridges, drought protection schemes, all that kind of thing. That’s going to take huge amounts of financing and that’s going to be one of the main drivers for more sovereign Green bond issuance, but mainly focused on adaptation rather than on the mitigation side, which sits more naturally in the private sector.
Nick Herbert: Would investors like to see more sovereign Green bonds?
Jacob Michaelsen: I think investors would like to see more Green bonds in general, and bonds from more diverse issuer types. It’s not specific to sovereigns, but I do think that sovereign issuance is welcome. Recent deals have done a tremendous job in showing that there can be green bonds with liquidity. It’s important to recognise however, as was said before, that it’s not straightforward for a sovereign to launch a Green bond. Here, the drivers behind issuing Green bonds are the politicians, and these are far removed from the people that actually make a deal happen, the ones that do the work.
I would also say that while I understand the market wants to talk about sovereigns - because it’s a new and novel aspect of the Green bond market, what the market really needs is more corporates. This product is still predominantly high-end, high investment grade but we need other issuers. You see the occasional Triple B company coming to the market, but they are rare. There are hardly any high-yield or crossover issuers.
If we really want to move the needle, we need to make sure that we continue the journey down the ratings structure. Clearly that would be a very interesting but that will need a new range of investors. The market has grown up as an investment-grade product, and that is reflected in the investor space. They aren’t there in the high-yield world. Yet.
Tallat Hussain: It makes absolute sense to encourage corporates to launch Green bonds, whether it’s in the developed or the developing markets. But sovereigns are very important, particularly for emerging markets, as once a sovereign develops the framework for green finance, and the regulatory infrastructure to support it, this gives issuers within the country not only an example, but also the ability to follow their lead. I think that’s one of the most important aspects of a sovereign Green bond issue. It’s also an indicator of the implementation of green commitments from the top down.
Sovereigns issue bonds all the time, so it’s not actually that big of a deal if a bond is green or not, as it’s not materially different from any other sovereign bond. But the impact of issuing a green sovereign bond is actually much deeper. It encourages the market for green finance and that’s more important in emerging markets. Nevertheless, we’d love to see the UK issue Green bonds as I think that actually would also encourage municipalities and show support for green finance that will trickle down to corporates and other entities. And that’s perhaps the space where all the work gets done to address climate change, environmental protection and sustainable development. Of course, the US does have an active Green municipal bond market although it doesn’t have a Green bond framework at the federal level. However, for the UK, one of the things we would need in order to encourage more municipal green finance is something like a UK sovereign Green bond.
Nick Herbert: In terms of the investment demand for emerging market Green bonds. I know the EIB is playing its part - it has invested in the Amundi Green bond fund, but how do you see an MDB’s role as the market develops?
Irene Sanchez: One of the roles of the EIB is to help develop local markets in countries where there is an EU mandate that supports EU development. For example, through the participation in the Amundi fund, the EIB is trying to incentivise financial institutions in emerging markets to issue Green bonds. The EIB is investing US$100m as a junior tranche in order to help catalyse the participation of institutional investors.
But there are more ways in which MDBs can add value in emerging markets in order to build capacity of local financial institutions to issue Green bonds, such as providing technical assistance This is one
way to decrease funding costs for issuers and ultimately for investors. For example, we can help guide potential Green bond issuers in emerging markets to facilitate the adoption of international best practices by helping them select projects that meet certain level of environmental and social standards.
MDBs can also help by developing innovative instruments to fund emerging markets. For example, the Luxembourg-EIB Climate Finance Platform is the first example in which a member state directly funds a climate finance platform. This platform invests in high-impact projects in renewable energy and energy efficiency in emerging markets but also in Europe. This is another way of harnessing funds from public institutions to attract private investment towards impact investing.
I am really passionate about the innovative footprint of the EIB and think it’s essential to highlight the role of the multilateral banks, not only from an issuance perspective, but also through the development of best practices to help crowd-in private investors in order to bridge the sustainable investment gap.
Nick Herbert: Not all corporates or borrowers have the potential to launch bond-sized deals. Shouldn’t the banks be doing more in terms of green lending? What implications does that have for securitisation?
Julie Becker: For sure, aggregation is clearly the new word when we talk about progress in green finance today: aggregation of asset-backed securities, mortgage-backed securities, covered bonds, securitisation of Green loan investment fund portfolios. It promises the appearance of many sustainable financial instruments in the near future.
Nick Herbert: Banks in general should be doing more shouldn’t they? They have the capacity to really change the green agenda through their business activities. Or does their exposure to brown assets prevent that change in behaviour?
Jacob Michaelsen: Certainly they should. So should, I would say, everyone else. But clearly banks are in a somewhat special situation as they are the aggregator, the promoter and the facilitator of the market. What the Green bond market has allowed for is a way for banks to become engaged in sustainability in a fairly unencumbered way and in a way that uses our traditional platform. I think that has been the reason why you’ve seen banks really embracing this discussion.
Clearly, green lending is something that banks need to encourage (and the Green Loan Principles will bring some discipline to this market), as they provide such a big proportion of loans to both bond issuers and to companies throughout the economy.
Otherwise, we clearly see that banks are trying to source greener assets. To a certain extent, this pursuit of green assets allows for the issuance of more Green bonds but it also gives room to expand the discussion with clients. Nevertheless, to simply say that banks should do more Green loans is perhaps easier said than done.
Nick Herbert: Jaspreet, how do banks fair on your sustainability scorecard?
Jaspreet Duhra: It depends on which bank and where they are or what they’re doing. We have a sector specific approach in terms of our criteria. So, we’re very much looking to see generic ESGs used in employment rights and governance issues, but with regard to banks it’s important to look at where they’re lending money. That’s a prominent part of the assessment we do when it comes to banks and asset managers, and the portfolios they hold. As ever, we have absolute minimum requirements, so you do get some banks that we think are doing a very good job and others that aren’t doing such a good job in that area.
Nick Herbert: Thank you very much to our panellists and their contribution to an interesting and vibrant discussion.
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