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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