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.
To see the digital version of this roundtable, please click here
To purchase printed copies or a PDF of this report, please email email@example.com