Green bonds provide funding for activities that have positive environmental benefits. As such, they are an increasingly important enabler of the global push toward lower carbon emissions. The first green bond came to market in 2007. Since then, steadily increasing issuance has reflected strong supply and demand. On the supply side, corporate efforts to strengthen green credentials have accelerated, which has been matched by growing investor demand for green investments.
In the March Budget, Chancellor Rishi Sunak announced that the UK government would issue two inaugural green government bonds, or ‘green gilts’, with the first issuance in summer 2021 and the second later in the year. The UK government plans for this to be one of Europe’s largest green bond issuance programmes to fund the response to the Covid-19 pandemic and to place the UK as a centre for sustainable finance ahead of COP26.
So far, 16 other countries have already issued green sovereign bonds, including Germany, France and Poland. Governments have long played an indirect role in redistributing capital towards greener activities by implementing policies that incentivise sustainability. However, the shift to green sovereign bond issuance signals a move towards direct government financing of carbon-friendly activities.
The sustainable bond market has expanded considerably since the inception of green bonds 14 years ago. Investors can now purchase from a whole spectrum of ‘sustainable bonds’, including social bonds, sustainability bonds, as well as green bonds. More recently, social bonds have gained significant traction as attention on the S element of ESG has increased. The ongoing Covid-19 pandemic has amplified this trend, with surging issuance related to funding virus support measures, such as vaccine bonds and recovery bonds.
According to Moody’s, sustainable bond (green, social and sustainability bonds) issuance totalled a record high $127.3bn in the third quarter of 2020. This was a 30% increase over the previous quarter, which had also seen record high issuance. Despite sustainable bond issuance increasing year on year, in our view demand still far outweighs supply. This is reflected in most issues being oversubscribed. Accordingly, the global pool of fixed income investors aiming to invest responsibly can no longer be considered a niche market.
It’s not just institutional investors who are keen to allocate capital towards sustainable objectives. The democratisation of savings is also giving retail investors more avenues for allocating capital in line with their beliefs. From this perspective, the issuance of green gilts is a win-win strategy: supplying a broad investor base with a much sought-after green instrument, enabling the transition to a net-zero economy, as well as boosting the government’s green credentials.
Responsible investors should be wary of taking bond labelling as ‘green/ social / sustainability’ etc. at face value. This is because the sustainability credentials of some labelled bonds can be overstated or, worse, subject to ‘greenwashing’ or ‘social washing’. In these cases, a non-labelled bond issued by a Paris-aligned and credible sovereign could be preferable. A key requirement we think is to look past labelling and judge the likely sustainability impact.
By way of example, in 2018 the Indonesian government issued its first green bond. However, despite its green label, when looking more closely at its planned ‘use of proceeds’, it became apparent to us that this included an element of deforestation, we therefore decided to exclude this bond from our eligible universe.
It is critical to assess the financing framework of green bonds. This is where professional investors can play a key role in ensuring that client money is allocated in line with expectations. While reliance on labelling should be avoided, we do nonetheless see value in a well-established framework .This is because reliable labeling can serve as a useful signal that can help to raise overall quality of sustainable bond markets. Indeed, for our part, we have played an active role in encouraging the UK Treasury to closely align with internationally accepted ICMA Green Bond Principles.
In the case of green bonds, there is also a need to assess the overall green strategic direction of issuers. With respect to the UK’s planned green gilt, we feel the government’s roadmap for achieving ‘Net Zero’ by 2050 is credible. Furthermore, the government’s consistent strategy in this regard is supported by numerous indicators showing significant progress.
We see the UK government’s planned issuance of its first green gilt as a positive market signal of its commitment to funding green projects. This is part of a broader positive trend of governments increasingly looking to progress from indirect (i.e. policy) to more direct (i.e. funding) support for green initiatives. For responsible-minded investors, this means increasing opportunities. However, amid surging issuance, careful due diligence is needed to ensure labelling matches up to both reality and investor expectations.