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Green Gilts would be a political act

Green climate protest protester from Alamy 230x150
By Jon Hay
21 May 2019

Investors are calling on the UK to issue green bonds. Should it? There is little doubt markets would like them — but the important question is, would the public?

Columbia Threadneedle must have a great PR team. Or its portfolio manager Simon Bond has a superb sense of timing. Either way, his open letter last week to Sir Robert Stheeman, the UK’s debt management chief, calling on the UK to issue green Gilts, has made a bigger splash than even he may have hoped.

Though the idea is not new — it was firmly recommended, for example, by the UK government’s own Green Finance Taskforce in March 2018 — Bond’s letter has garnered widespread attention and pushed the idea of green Gilts back on to the agenda.

Other investors have backed him up, including Joshua Kendall at Insight Investment and Johanna Köb at Zurich Insurance.

Environmental guilt

But the attention this time likely has much to do with the recent steep surge in public awareness of climate change. School boycotts and Extinction Rebellion protests have helped shake the stifling complacency about this issue. Millions of people accept the reality of climate change, but ignore it.

Governments are the same. The UK has one of the best records on trying to decarbonise its economy, but progress has been far too little, too late. Climate change has been widely known since at least the 1980s, yet still only about a third of the UK’s power is renewable, and that includes biomass, which generates carbon dioxide emissions.

Are the investors right to push for green Gilts? They may be, but constructing a case for it is not straightforward.

Bond’s letter emphasises that there would be “significant appetite from pension funds, insurance groups, endowments and family offices across the globe” for such bonds, and describes the growth of the green bond market. It does not offer specific arguments for the UK to issue them.

That the government needs to act decisively on climate change is beyond question. Its best option would be to adopt the advice of its independent Committee on Climate Change earlier this month, and legislate swiftly a set of policies to deliver net zero carbon emissions as early as possible — even though the CCC’s policy prescriptions are not perfect.

Some government spending and investment will certainly be required, and ideally a lot. Whether the government should raise this money with green Gilts is an entirely different question.

Keen appetite

Asset managers running green bond funds are eager for the paper. They have money pouring in from clients who want to invest greenly, and scanty places to put it.

The green bond market is very uneven and lopsided from a portfolio manager’s perspective. Isolated issuers such as the French Republic, China’s Industrial Bank, Iberdrola and Electricité de France make up large shares of the market. Other spaces on the global debt map are virtually blank — and the UK, until recently, has been one of them.

When the Thames Tideway Tunnel issued its first green bond in 2017, for £250m, it doubled UK issuance that year. The next day it issued a private placement and doubled the whole UK corporate stock of green bonds outstanding.

But making life easier for asset managers is not a compelling policy aim — and nor is satisfying the end investors who want their money to do good.

Cost efficiency

Green Gilts need to serve a purpose for the government. The UK has plentiful access to funds. With about £1.8tr of public sector net debt, its 30 year bonds yield around 1.6%. It does not really need a new market or product, with which to finance green investments.

Debates go back and forth about green bond pricing. GlobalCapital has argued consistently for many years that green bonds ought logically to be priced at new issue more tightly than comparable ordinary bonds, and that in practice they often are priced more tightly.

A recent run of corporate green bond issues from Philips (flat to its curve) Vesteda (5bp through its curve), Tennet (NIPs of 1bp and minus 2bp) and Vodafone (green tranche 3bp through curve, other two 7bp above it) illustrates this.

But issuing green bonds also involves cost, above all the administrative work needed to earmark projects for specialised funding, and to prepare detailed reports for investors.

Government debt management offices have one job: to fund the national debt as efficiently as possible. It is not their role to experiment with new products, if these could cost the taxpayer money.

As Columbia must know, Sir Robert Stheeman has no power to decide to issue green bonds — it would be up to Philip Hammond, the chancellor of the exchequer, and would be sure to be a cabinet decision involving the support of the whole government. This has been the case at all the other governments that have issued green bonds.

If the Treasury wanted to explore issuing green bonds, it would be sure to ask the UK DMO’s advice. Here the cost issues would come under scrutiny.

Administrative costs for the bonds would arise at many departments, though might be considered centrally.

But the pure financing implications would depend on whether the extra demand for green Gilts — which would certainly be there — would compensate for any potential illiquidity premium if the green Gilts had to be smaller.

The evidence so far from other governments is encouraging — green government bonds trade as well as, or slightly better than, ordinary paper.

Real reasons

So there is a good chance that green Gilts would be an efficient financing mechanism.

That is a necessary condition for issuing them — but still not a sufficient reason.

The UK might, if all went very well, save a net half a basis point, a basis point, perhaps 2bp. Is that worth the effort — above all, the ministerial and departmental time involved (which would include changing the law to allow hypothecating debt proceeds)?

Surely not. 

Saving small amounts of money is certainly the DMO's job, but from a green point of view, which must be the policy motivator for issuing green bonds, a saving counted in single basis points is smaller than a rounding error. It would make no difference to the viability of any green investments the government might contemplate.

Green bonds were invented as a signalling tool — cynics might say, one for virtue signalling.

And it is as a signalling mechanism that they have mainly been used by governments — from France to Poland to Fiji.

The UK does not need to blandish its environmental credentials to the world. They are decent, not impeccable — but surely the country can rely on its actions, such as further greening its power, transport and housing, rather than bond issues, to make this known abroad.

Home crowd

The decisive role green bonds could play is in domestic politics. As climate change — and other environmental issues such as plastics — rises up the agenda, they will become more political.

It might be very useful for the government to be able to point to the green Gilts as a tangible sign of what it was doing on the environment — and one that ordinary people could get involved in, by buying the bonds.

Those wanting to argue that the government was doing too little could point to this pygmy market, against the giant Gilt stock, and argue that the nation should up its game.

But this could cut the other way too. Climate change sceptics are rare in the UK — but so were Brexit supporters five years ago. Opponents of environmental investment could use the green Gilts as a visual flag of the “green debt burden” the UK was taking on.

Ultimately, green Gilts' most important role and purpose for the UK would be as a political instrument.

There is a risk of giving ammunition to the old guard of fossil fuel defenders, who will get much more vocal in the coming years.

But on balance, the more hopeful argument that green Gilts could help mobilise the country to support green investment should prevail. Over to you, Mr Hammond.

By Jon Hay
21 May 2019