LAST WEEK THE G20 produced a communique from its annual meeting, this time held in Hangzhou in China, which for the first time mentioned Green finance as a critical input into the future of the global economy.
It seems everything is going green these days, following the Paris climate accord, or to give it its full appellation “the COP21”, which was passed last December but has yet to be ratified by all consenting parties. Only 26 of the 200-odd signatories have ratified the agreement.
A fillip was provided last week when China (the world’s biggest greenhouse gas emitter) and the US (in second place) agreed at the G20 to ratify the treaty. Quite whether Barak Obama can sidestep Congress and get it through as part of his increasingly urgent legacy is anyone’s guess, but it seems the Republican climate change sceptics, of whom there are many (Donald Trump included), may have to live with it.
Last week I attended the annual meeting in Singapore of the Principles For Responsible Investment, a United Nations-sponsored programme which aims to foster environmental, social and corporate governance (ESG) awareness among global investors (Disclosure: I must say here I have a small role in assisting the PRI with its public relations in Asia). Its 1,500-odd signatories collectively manage around US$60trn of assets.
ESG is hip right now and in the aftermath of COP21 has garnered an urgency which was unthinkable to most market players just a few years ago.
There is talk of a “quiet revolution” in global finance, where increasingly Green finance is encroaching on the conventional sector with seemingly unstoppable momentum. Indeed, the pact between the US and China to ratify the COP21 agreement last week has turned up the volume on that revolution.
IF YOU ARE sceptical towards climate change and happen to manage a fixed-income portfolio you might have to live with the possibly unwelcome reality that the big ratings agencies are now incorporating ESG considerations into their ratings methodology. That dynamic seems to yield more ratings downgrades than upgrades, but you would be unwise to exclude it from your own take on the credit picture.
You might love the financials of a Chinese or Indonesian corporate wherein the cashflows derive from fossil fuel, but the risk of that company eventually sitting on “stranded assets” due to regulations based on COP21 and experiencing a plummeting ratings dynamic as a direct result cannot now be ignored.
Indeed, as well as the ratings agencies there are moves from index compilers such as MSCI to craft a range of green indices for benchmarking purposes, and if those indices prove to outperform their conventional equivalents – as the ESG community suggests is a looming secular reality – then they will in that process draw in a wall of money.
For equities it’s more straightforward and the index dynamic is kicking in big time. The MSCI in March launched its fund metrics tool that measures ESG elements in over 23,000 mutual and exchange-traded funds. That sort of analytical weapon helps in the divestment stakes and there is already a brutal fossil fuel sell-off happening in equities, with some mammoth players such as the Norwegian oil fund and the pension funds of Sweden and Denmark having ditched coal-related assets this year.
If not everyone has had a conversion on the road to Damascus when it comes to investing along ESG lines, the chances are that moment is not far away.
ONE OF THE ironies of it all is that when you take fixed income (rather than equities) the Green bond product, which has come from virtually nowhere just a few years ago, offers no discernible advantage from either the issuer’s or the investor’s point of view.
Indeed, when it comes to issuing Green bonds, the cost incurred for obtaining the necessary second and third-party diligence which supposedly ensures a bond really is Green over its life – normally US$20k–$100k upfront – is a turn-off for many issuers.
Add in the fact the product doesn’t price through the implied curve for conventional issuance and you begin to wonder why the Green bond market is in its prevailing gangbusters state. It’s estimated the Green bond market will smash last year’s US$44bn total for global issuance and break through the US$100bn mark by the end of this year.
But how to express the relative value of the Green bond universe? Will there ever come a point when you can enter the market and short the conventional bonds of an issuer and go long its Green bonds at the same duration with a view to the spread tightening?
If the Green finance revolution is real and the COP21 is not a chimera, then it seems likely to happen. One possible input that might prompt the outperformance of Green bonds is a tax break that favours issuers and investors.
Mind you, it might just be the (increasingly loud) quiet revolution does it on its own. However it pans out, no investor can afford to bury his or her head in the sand when it comes to ESG. The sceptics may be angry, as is the way these days, but I suspect their conversion is not only inevitable but advisable.
