Canada’s first green bond highlights laggards

IFR 2417 - 22 Jan 2022 - 28 Jan 2022
6 min read
Julian Lewis

The imminent launch of Canada’s debut sovereign green bond has highlighted continuing controversy over the product financing nuclear power, as well as the absence of the US and Japan from the green bond market despite their standing as the world’s two largest government bond issuers.

Ottawa will launch its first green bond this quarter, fulfilling its earlier undertaking to enter the market “to support the environment and climate change plan” before the end of its 2021–22 financial year on March 31.

The deal “will be the first of many issuances”, according to the government's announcement in the 2021 budget.

Some market observers had expected Canada to enter the market before the COP26 international climate summit in November, as G7 peers Italy and the UK did. But the sovereign went silent after June when it appointed HSBC and TD Securities as its structuring advisers.

Nonetheless, Canada continues to target C$5bn (US$4bn) for the transaction, which it will issue under a green bond framework that it has yet to publish. Although the appointment has not been announced publicly, Toronto-headquartered Sustainalytics is providing a second-party opinion on the framework.

Nuclear option

One controversy is the potential inclusion of nuclear power in the sovereign’s framework. Until now, even strong supporters of nuclear power, such as France and the UK, have excluded the energy source from their green frameworks.

However, Canada’s growing nuclear capacity and the fact that nuclear power may feature in the EU's taxonomy of sustainable activities have led market observers to speculate that Ottawa may break with these precedents – particularly after domestic utility Bruce Power in November issued the first green bond to fund nuclear power.

Explicit nuclear use of proceeds appears unlikely. But the sovereign could position itself for eventual inclusion by not excluding nuclear expenditures.

“My hope is that there's not an exclusion,” said Jonathan Hackett, head of sustainable finance at BMO Capital Markets. “That will really support an eventual adjustment when the time comes for revision.”

Several sovereigns have asked banks about whether they should include nuclear power in their sustainability frameworks since Bruce Power's landmark deal – especially after the deal received a positive second-party opinion from Cicero Shades of Green.

That is sensible, Hackett argues. “Especially for sovereigns, you're talking about your strategy for achieving net zero and the tools that you're using to achieve it. It seems to me contrary to that goal to exclude one of the key levers that you have in achieving decarbonisation,” he said.

Absent US and Japan

At the targeted size, Canada’s inaugural deal will bring total G7 sovereign green bond sales above US$110bn in the five years since France’s groundbreaking “OAT verte”. Yet the world’s two largest government bond issuers remain outside the market.

The US’s absence is especially striking as the Biden administration’s first action on taking office was to rejoin the COP21 Paris Agreement on climate change. It has since set a 2030 emissions target and made a raft of commitments at COP26 – including on methane and international climate finance, as well as co-operation with China on climate change.

“Green US Treasury bonds would be exceptionally impactful – a reference for the whole world. It’s really a missed opportunity,” said one head of capital markets.

Market professionals suggested that the administration’s legislative failures may have impacted the Treasury’s appetite for new initiatives.

“We expect US dollar green bond issuances to gain momentum over 2022, which could at some point be followed by a US green Treasury. Yet Biden is still struggling to get the approvals to deliver on his climate pledges. This is likely to postpone further such inaugural issuance,” said Johann Ple, senior portfolio manager at Axa Investment Managers.

Green bond advocates expect both heavyweights to come to the market eventually, and to make quite a splash when they do. "Imagine how much of a fillip to the market it would be if we saw a US green Treasury or a Japanese green sovereign,” said Sean Kidney, CEO of the Climate Bonds Initiative.

Current sovereign green oversubscriptions and premium pricing “will be getting lots of governments to take a closer look”, Kidney added.

With the US and Japanese governments having made significant commitments to climate action, “I would not be surprised if it's on their radar", he said.

A spokesman for the US Treasury declined to comment on its green bond plans “at this time”.

Japan’s Ministry of Finance did not respond to a request for comment. But Masato Kanda, vice-minister of finance for international affairs, made notably negative comments on ESG bonds in December, including a worry that “outsiders” would determine the government's expenditure.

Social pioneer

Although itself a latecomer to the green bond market, Canada is also looking to pioneer social bonds. It remains on track to become the first major sovereign to offer the product (not counting the European Union), having announced in the 2021 budget that it will “explore the potential for issuance”.

It cited social bonds’ capacity to “support investments in a variety of areas that promote greater social inclusion and broad-based economic prosperity”. These include early learning and child care.

The sovereign discussed the product with market participants in its annual debt management strategy consultations in October. The Bank of Canada also participated.

“The government continues to explore the potential for social bonds,” a spokesman said. “Discussions with partners are ongoing.”