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France may help green bonds, but no subsidies yet

Green bond

The French government is open to using its “soft power” to help the green bond market, as it did when it assisted in establishing the Euro Private Placement (PP) market. But tax or regulatory capital incentives are unlikely at the moment, reports Jon Hay.

Ways the public sector could help the green bond market were discussed at a conference in Paris on Wednesday, held to launch a report by a new think tank called the Institute for Climate Economics (I4CE).

The conference was held under the Chatham House Rule, which forbids quoting speakers by name.

“I do think the public sector has a role to play, for sure,” said one speaker. “There are many debates about boosting the market through price. I’m not sure it’s the right way.”

The comment referred to the idea, more and more commonly discussed, that the public sector could subsidise green bonds, with either tax breaks or easier regulatory capital treatment for investors such as banks or insurance companies.

“Don’t ask too much of the public sector, especially when the tax framework is the one we have today,” said one speaker. Nor was capital regulation the right instrument to use, he said, as its purpose was to protect the financial system from risk.

But there are other ways for the public sector to help. In 2012-14, when French banks, issuers and investors were creating a new Euro PP market, the Trésor and Banque de France helped to convene and encourage discussions. These led to a regulatory capital change for French insurance companies, but also to guidelines on best practice that have helped stimulate issuance, estimated last year at €8.6bn.

On green bonds, the state could give suggestions, ask questions and “just give an impulse through ministers saying the public sector wants it to succeed”, said one speaker. “I’m glad this kind of soft power remains — it avoids a lot of work doing laws, which is exhausting.”

If France did start to help the market, it would want it to be an international initiative.

Enthusiasts’ hopes that governments would subsidise green bonds leapt forward last year when China set rules for green bond issuance. It has not yet applied subsidies, but has working groups on the issue.

“Our advice to them is to leave it till next year,” said Sean Kidney, chief executive of the Climate Bonds Initiative (CBI), an NGO in London. “Get your governance right first. Let it bed down.”

The Securities and Exchange Board of India has also published guidelines for green bond issuance.

In most other countries, governments and regulators have yet to get involved. Even without their help, the green bond market grew to $41.8bn of issuance last year, according to the CBI. But this is a drop in the ocean compared with the trillions of dollars of investment estimated to be necessary between 2015 and 2030 if the world is to avoid catastrophic climate change.

Gains limited so far

The I4CE report, entitled Beyond Transparency: unlocking the full potential of green bonds, pointed towards the potential for tax or regulatory subsidies to make green bonds more effective.

This thrust flowed from the report’s conclusion that: “To date, there has been little evidence that green bonds attract new financing beyond what would have been available through traditional bonds.”

Some market participants have admitted for years that green bonds, as they exist now, are not increasing investment in environment-friendly projects. Green bond issuers are doing the projects anyway and could finance them just as well with other sources of money. But few have been keen to say this publicly.

That appears to be changing. At the conference in Paris there was more open discussion of the limitations of the green bond market’s achievements so far than is usual at such events.

Kidney, who was willing to be quoted on his remarks, said: “The green bond market has made zero contribution to date” to shifting investment on to a low carbon path. The deals that had been done were a repackaging of existing investment flows.

He hailed the issuers, investors and banks which had created the green bond market as “pioneers” but said: “It has to be understood as a journey.”

Thanks to China, green bond issuance will hit $100bn this year, putting the market back on the growth trajectory it showed in 2014, but Kidney said: “Above $300bn a year we are moving the needle. We need to get to $1tr a year in 2020.”

Whipping up interest

The I4CE report said that so far, the main benefit to society from green bonds had been a slightly better matching of green capital with suitable investment opportunities.

Speakers at the conference emphasised green bonds’ role in building engagement, interest and skills in sustainability issues among investors, issuers and investment banks.

One said: “It’s a market with many different actors — not just investors, issuers and intermediaries — it’s a sign of vitality that so many actors are interested, like universities and even the Church. It’s a trend that will deepen.”

But the report identified two linked challenges for the market.

The first — protecting the environmental integrity of green bonds — involved defining what counted as green and improving reporting and verification standards, to avoid damage to the market from accusations of greenwashing, and possible legal action from dissatisfied investors.

Despite market participants’ thirst for one set of answers to the question of what is green, the report said: “It is probably utopic to expect one commonly agreed standard on the ‘green’ characteristics of bonds.”

Standards of verification and second party opinions on green bonds so far have been mixed, speakers said. “We need to drive the quality of second opinions, many of which frankly have been rubbish,” said Kidney.

Search for financial benefit

I4CE’s second challenge — enhancing the financial benefits — was to get the green bond market to the point where it could lower the cost of capital for green projects, and make it easier for such projects to be financed.

This could happen organically, if enough capital were committed to the market to create a substantial excess of demand over supply, forcing spreads tighter, the report argued.

In fact, there is plenty of evidence now that green bond issues both trade tighter than similar conventional ones in the secondary market, and can be priced more tightly at new issue. This is logical, since the bonds offer investors extra — non-financial — value.

Market participants used to be reluctant to admit this, since they did not want to put end investors off buying green bonds. But it is now more and more openly acknowledged.

But the I4CE report said such a “green premium” would need to be big enough to cover the whole primary green bond market for it to make any difference in stimulating investment, and for the moment it remained “theoretical”.

The green bond market could lower the cost of capital for small green projects by bundling them together, through securitisation or other means, into bond-financeable pools, I4CE said. But such deals could happen without being branded green bonds.

Public support could reduce the cost of capital through green bonds, the report concluded, but would have to be balanced against other uses of public money, for example, applying subsidies or regulatory incentives directly to the green activities, such as renewable energy.

State help to define green?

Participants at the conference were not clamouring for subsidies — as one pointed out, bonds are a tax-efficient investment already — but there is clear interest in the idea.

If the public sector does provide financial support, that will bring to a head the question — so far put off — of defining what counts as green.

Two speakers said that even if no subsidies were on offer, they would welcome governments, such as that of France, taking a lead in defining the market, by setting out what they considered the right projects to be eligible for green bonds.

In January, France created two certification standards for socially responsible investment products. One is an SRI label for those funds. The other, the Energy and Ecological Transition for Climate (TEEC) label, is to “spotlight the investment funds that finance the green economy”. It used a taxonomy from the CBI, Kidney said.

One speaker suggested using TEEC as a basis for discussing a definition of green with other national governments, such as those in the UK and Germany.

But the most thorough and concerted effort to set standards of greenness for the green bond market remained that of the CBI, participants said. The CBI believes scientists, not governments, should be the arbiters of what is green.

The International Capital Market Association, which manages the Green Bond Principles, is keen for a deeper dialogue with the public sector and once this got going, would create a dedicated mechanism for it, as it has with the French and German authorities for its work on private placements and Schuldscheine. Meetings with the European Commission have begun.

Other points raised at the conference included the somewhat limited role so far for the 71 organisations that are observers of the Green Bond Principles — one speaker was frustrated that observers had not been able to contribute their views.

ICMA tried last year to include observers in its working groups but only succeeded in some cases. It intends to make a fresh push on this at its annual general meeting next week.

I4CE was set up last year by French development body Agence Française de Développement and state bank Caisse des Dépôts et Consignations. The green bond report was funded, to promote better research on the green bond market, by Crédit Agricole, Electricité de France, which has issued two green bonds, and Mirova, the French responsible investment firm.