How green is your budget?
‘Look at the issuer as a whole’ is the mantra of the corporate and supranational green bond markets, and rightly so. But we need to apply the same approach to sovereigns.
The fact is that sovereign green bonds, although they have been important for developing standards, are too limited. Despite tens of billions of dollars of them being issued each year, they make up a minute part of countries’ balance sheets and give little indication of the overall impact of how countries spend their money.
Sustainability linked bonds are better than use of proceeds bonds in this respect, in that they assess a country’s overall performance. It takes a brave treasury department to give itself such a clear line for success and failure on sustainability. But even if every country that has issued green bonds were to issue sustainability linked bonds, this would still only be a handful of instruments.
Brussels-based think tank Bruegel has proposed that sovereigns adopt “green budgeting principles”, through which bond investors and others can consistently assess the sustainability of national budgets. This would open up a whole new perspective on socially responsible sovereign investing.
For instance, Spain may have a lower carbon footprint per capita than Italy, but what if Spain’s budget indicated that it was investing more heavily in transitioning to sustainability? Consistent benchmarks for assessing government budgets would open the asset class of government bonds for ESG analysis.
Investors no doubt already do this to a degree, and it is even more commonplace in other asset classes, but homogenising the standards they use and pushing countries to make greater disclosures would make a huge difference.
Not every country will want to offer investors the opportunity to scrutinise their budget’s climate impact, but the benefit of giving in on budgetary disclosures could be far greater than that of issuing a one-off green instrument.
When the Sustainable Finance Disclosure Regulation came into force in March, investors began to desperately need climate impact information. Bonds issued by countries that provide the requisite transparency would have an immediate competitive advantage across their whole debt programmes over those issued by countries that don’t.
Australia may be forced into becoming a leader in this field. Law student and retail bond investor Katta O’Donnell has brought a claim against the sovereign in court to force the government to calculate and disclose the risks climate change poses to its credit quality.
Fires, droughts and extreme weather events could have material impacts on Australia’s credit quality and thereby its bond prices. More immediately, there may be reputational consequences to lagging on climate action. Sweden’s central bank has divested assets related to two Australian states over their climate footprints.
It is time to abandon the pretence that green bonds are good and conventional bonds are neutral. Money is fungible, and government bonds fund a huge range of activities. What is really needed is a framework to assess all of them.