Green bond bulls run free
Having already racked up $200bn of new issues in the product’s first decade, green bond bankers now have far more ambitious goals in sight. Following sovereign endorsements and with strong growth ahead in emerging markets and structured finance too, they even aspire to an eventual double-digit share of the global bond market. By Julian Lewis.
The OECD recently forecast that the global green bond market could exceed $5tr in less than 20 years. It sees annual volume in China, the EU, Japan and the US alone reaching $620bn-$720bn a year by 2035, with the 2020s offering “the potential to be the start of the ‘golden years’ for bond issuance in the low-carbon sectors.”
Bullishness abounds in green bonds these days. “My dream would be that in five years’ time this market will reach a size of $1tr, which will enable it to be so large and important that it will have its own dynamic. We are heading in the right direction for that,” argues Tanguy Claquin, head of sustainable banking at Crédit Agricole in Paris.
Over the same horizon Christopher Flensborg, head of climate and sustainable financial solutions at SEB in Stockholm, “sees potential for the market to be 10%-20% green” and anticipates that “all bonds are going to have a greener profile, which is not to say that all will be green.”
“We’ve got a pretty reasonable shot at the goal of a $1tr market by 2020,” adds Sean Kidney, chief executive at the Climate Bonds Initiative, an investor-focused not-for-profit organisation.
These projections assume governments start aggressively financing through green bonds. The long-awaited arrival of sovereign issuers suggests this shift is starting.
Following France’s ground-breaking €7bn 22.5 year green OAT in January and a smaller private offering from Poland the previous month, as many as seven to 10 other sovereigns are queuing up to get their own green issues away.
This group includes developed and emerging economies. More than one candidate is European, say market sources.
One hotly tipped name is Sweden. Even though Swedish investors and the krona market have been at the centre of the green bond market, going right back to the World Bank’s first green bond issue in 2008, which was bought in kronor by two Swedish state pension funds, Sweden itself has never issued. But the government has commissioned a study on the product’s viability, which is due to report later this year.
The bulk of candidates are EM names, however. China — where the central bank’s chief economist has forecast that green bonds will claim a 20% share of the domestic debt market — towers over this group. Others include Bangladesh, Kenya, Morocco, Nigeria and the Philippines. Some Latin American sovereigns are also mulling issues, sources say.
Nigeria was due to launch a $60m-equivalent debut green bond in naira in March. But the government’s budget process delayed the offering.
Still, with France’s debut having attracted close to €25bn of orders, optimism is high. “The emergence of sovereign issuers is a key development for this new asset class. Sovereign issuers are not only among the largest in size but also some of the strongest in terms of credibility and adherence to market standards of best practice,” says Ashley Schulten, head of climate solutions, fixed income at BlackRock in New York.
International undertakings, particularly from 2015’s UN Climate Change Conference in Paris, are pushing sovereigns towards green bonds. “The product is a fantastic tool to drive climate policy commitments,” says Crédit Agricole’s Claquin. “I expect much more to come from sovereigns, who are all keen to demonstrate their progress on COP21. I don’t know if it will be quick, but it will come.”
Emerging markets are likely to prove an increasingly fertile source of activity. Already China and India are key sources of growth, while Chinese activity falling back explains Q1 17’s weak volume.
Latin American markets are also starting to gain momentum. For example, Mexico’s Nacional Financiera has issued local currency green debt, while a ground-breaking $2bn deal for Mexico City Airport also emerged last year.
Besides EM sovereigns, development banks, local authorities, commercial banks and even corporates are all likely to start funding through local green markets, market players forecast. As many as six new EM agencies should issue this year, CBI’s Kidney anticipates.
One big landmark came in April with the International Finance Corp and Amundi’s $2bn Green Cornerstone Bond Fund. It will buy green bonds issued by EM banks, with IFC contributing $325m and taking first losses.
The fund expands a role IFC has already played in Colombia and India, where it facilitated local green bonds from Bancolombia and Yes Bank by issuing back-to-back offerings in pesos and rupees.
Brazil’s BNDES established a similar R$500m domestic fund in December.
“This kind of ice-breaker support will help emerging market banks come to market at reduced cost and grow the market,” Kidney says.
Apart from China’s accommodation of so-called “clean coal” in its domestic green bonds, corporate issues have proved the most controversial. Critics charge that industrial companies have exploited the product as a cynical way of “greenwashing” their pollution records.
Market players dispute this. Crédit Agricole’s Claquin acknowledges the risk the issue poses to the market’s integrity and concedes that the corporate sector “has not grown at the pace we would have liked,” but he insists that green bonds remain a valuable tool “to engage with companies — not to name and shame”.
Flensborg characterises corporate issues as “a rather positive trend to be part of a development that they find important,” though he cautions that the current strength of corporate balance sheets mitigates against bond financing.
The longer term outlook is positive, however. “We expect corporates to play an important role in the green bond market,” says Henry Shilling, senior vice president at Moody’s in New York.
The US corporate bond market could be key, despite the new administration’s scepticism over climate change. “We can get big scale out of the US,” says Kidney.
Another area starting to gain traction is green structured finance, though it still represents no more than 5% of outstanding green bonds. Most have been securitizations of energy-efficient car and residential mortgage loans, as well as US Property Assessed Clean Energy (PACE) loans.
Despite limited volume, these products “offer significant potential, particularly as a way of making otherwise lower-rated issuers or pools of assets appealing to institutional investors,” judges Shilling. “We expect the segment to grow relative to other segments of the market.”
Again, emerging markets could be a rich source. With ratings typically constrained by relatively low sovereign ceilings, the need for credit enhancement — whether through asset-backed structures or third-party guarantees, over-collateralisation or insurance — of green EM issuers and assets is clear.
Synthetic green securitizations are also starting. In a landmark transaction in March, Crédit Agricole transferred the risk on a $3bn portfolio of mostly non-green loans to Mariner Investment through a leveraged green capital note. Crédit Agricole has committed the $2bn of capital freed by the deal to new green lending.
Besides limited supply relative to demand, other challenges include concerns over the eligibility of new social bond projects in green bond pools.
“It’s important that we maintain the integrity of the green bond label,” says Schulten. “Reference to the Green Bond Principles should mean the same thing to a global audience: a segregated use of proceeds intended for projects producing significant environmental benefits.”
A larger uncertainty is the product’s capacity to provide as much scale as needed. “At these numbers, we’re still talking about a small fraction of the volume required to contribute meaningfully to the transition to a low-carbon economy,” cautions Shilling at Moody’s.
“Green bonds play a very significant role in sensitising investors to the challenges associated with climate change and bringing about dialogue between the financial and non-financial sectors. But there is still a lot more work to be done to transform this very small market into a much more meaningful contributor to greenhouse gas mitigation.”
One disincentive to more widespread adoption stands out. As investors remain unwilling to pay a premium for green debt, irregular issuers face a cost disadvantage in offering the product due to its external review and reporting requirements. One way out could be a universally accepted, consistent reporting methodology. This would enable investors to compare green bond issuers across sectors and determine relative value.
Another might be government incentives. In March Singapore announced a Green Bond Grant scheme for local listings that will cover the cost of external review. Discussions of tax kickers are also under way in China, Europe and the US.
Even so, Shilling concludes: “We cannot rely exclusively on green bonds — we need to leverage the broad tool set in capital markets to finance green projects and effect the transition.”