
Capital markets find a sense of purpose
Financial markets are often seen as cold, calculating machines for making money. That is part of their function. But increasingly, people are talking of markets’ broader social purpose — that they exist to serve humanity and make its existence healthier and more sustainable. Toby Fildes argues that, 10 years on from the crisis, this new ethos will govern the markets’ future.
These are unnerving times for all involved in global capital
markets. We haven’t quite gone to the financial equivalent of Def Con 1, but as
2018 draws to a close, the warning signals are flashing red.
Some — Brexit, an unpredictable and volatile US president,
slower growth expectations reflected in an increasingly flat yield curve, the
end of quantitative easing in Europe, Italy’s arguments with the European Union
over its budget — are beyond the control of issuers, bankers and investors.
Others are market-specific concerns, in particular fears
over when exactly the credit cycle will finally end, real estate bubbles and a
white-hot leveraged finance market that has been driven, in part, by energetic
CLO issuance.
Anyone who was working in the markets 10 years ago when the
global financial crisis struck could be forgiven for a sudden attack of déjà
vu. It is tempting to think little has changed since 2008.
But look a little closer and capital markets are very
different. Banks are much better capitalised (even though there is no still
universal standard of what capital should consist of); there is a lot more
non-bank finance, giving companies more choice and flexibility; regulators are
more practised at coping with critical moments and have more oversight of
banking systems; large swathes of the derivative markets have been moved to a
centrally cleared model and even Libor is being replaced (although again, there
is a lack of standard).
But there is another way markets have changed. When capital
markets people get together nowadays, talk is no longer just about coupons,
yield curves and cocktails. You are as likely to hear about the Sustainable
Development Goals or gender lens investing.
The attention being paid to sustainability in capital
markets would astonish someone who had time-travelled out of the Lehman
Brothers office in Canary Wharf on September 15, 2008 and into the Euromoney
Global Borrowers’ and Investors’ Forum in Mayfair on June 26, 2018.
Some talk of a new type of finance emerging — purposeful finance or inclusive capitalism. Ten years ago, such phrases might have been scoffed at. Now, they are taken seriously.
“The modern funding model can be characterised as finance
with purpose,” says Phil Jenkins, chief executive of Centrus, a corporate
finance advisory business in the UK that focuses on what it calls essential
service industries. “This it illustrated by pension funds and insurance
companies generating stable and reliable returns by directly financing
renewable energy, transport, power and water infrastructure or new affordable
housing.”
One of those insurance companies is Legal & General. Its
chief executive, Nigel Wilson, is a keen advocate of this new type of finance,
having this year pushed the concept of inclusive capitalism through various
media channels.
“Environmental, social and governance interventions by
investors are here to stay. Diversity, solar and wind power are happening, as
is decarbonisation and a reduction in plastic consumption,” he wrote in an
article in September. “Inclusive capitalism works as a way to finance economic
growth in cities governed by people of all political colours... Manchester,
Newcastle, Cardiff and other UK cities, and the same is true in Austin, Denver
and Seattle.”
Planting seeds
For many in the primary capital markets, this new age has
its roots in the years just before and during the global financial crisis.
The International Finance Facility for Immunisation’s $1bn
five year bond in November 2006, the European Investment Bank’s first Climate
Awareness Bond in 2007 and the World Bank’s first green bond in November 2008
were the pioneering deals that launched this new era for the global bond new
issue markets. Ten years on, these deals have generated the $500bn+ labelled
bond market.
On November 16 this year, the 10th anniversary of its first
green bond, the World Bank hosted an event, From Evolution to Revolution: 10
Years of Green Bonds, at the George Washington University.
Participants included representatives of the firms that
worked on the original deal, such as lead manager SEB, syndicate bank Credit
Suisse, investor AP2 and second opinion provider Cicero.
A theme of the event was how much capital markets have
changed over the last 10 years, from a market where investors knew — and cared
— little about what their investments were supporting, to one where purpose
matters.
Green bonds have played a key role, according to Heike
Reichelt, head of investor relations and new product development at the World
Bank and one of the architects of the original deal. “Green bonds have sparked
a revolution in thinking about sustainability, purpose and potential for liquid
bond investments to achieve a positive impact. Investors understand their power
to support initiatives their stakeholders care about, and that they do not have
to give up returns to do so. Investors also increasingly see the links between
environmental, social and governance factors and risk and opportunities in
their investments. An issuer with good sustainability practices will generally
be a better investment. Importantly, investors want data that shows how their
investment is creating social value — and issuers are responding. They are
engaging with investors to show how their bonds present opportunities to
achieve both financial and social returns.”
Market flourishes
From $349m issued in 2008, issuance of green bonds has
swelled and is expected to hit $150bn this year.
Would these volumes have been achieved without the World
Bank’s inaugural deal? IFFiM and the EIB had proved the socially responsible
investment drums were already beginning to beat in primary bond markets in the
two years leading up to the green bond. Consciousness of climate change and its
political and economic impacts was growing, given extra clarity by the
Intergovernmental Panel for Climate Change’s report in 2007.
“To some extent I think there would have been a development
towards a sustainable bond market anyway,” says Ole Petter Langeland, head of
macro, exposure, fixed income, FX and trading at AP2, and one of the investors
on the deal 10 years ago. “The trend in the financial markets towards
sustainable investing is of course not isolated to the fixed income market but
plays a role in most asset classes. The growing awareness of the issue of
sustainability and sustainable investments is more a reflection of the
development in the overall society. The financial sector is good in generating
investment vehicles where they see opportunities. Green and other purposeful
finance bonds are perhaps the cleanest way to express that as a fixed income
investor.
“That said, I do not think we would have come as far as we
have if the market had not started with issuers like the World Bank. I still
think the growing focus and attention that green bonds draw to sustainable
investing is one of their greatest achievements.”
Christopher Flensborg,head of climate and sustainable financial solutions at SEB in Stockholm,
who put the Swedish investors together with the World Bank 10 years ago, agrees.
“The time the World Bank invested in interacting with investors to allow them
to understand the value proposition and how to integrate the investments has
provided the platform for most of the early movers inside mainstream
investment,” he says. “It is unlikely that we would have found the way without
their clear leadership. However, initiatives like the Principles for
Responsible Investment [the UN-supported network of investors founded in 2005
to help develop a more sustainable global financial system] have been very
important as well.”
The correct answer to who or what was responsible for the
establishment and development of the sustainable bond market is therefore that,
in all likelihood, it was lots of different people and lots of different influences
— although the World Bank’s deal caught the zeitgeist and helped advance the
cause.
“One should not forget that this also was driven by
investors like ourselves, that wanted to deploy capital directed towards
sustainability but needed an issuer that we were confident could deliver,”
Langeland says. “One of the big advantages the World Bank has is their size and
the broad array of projects in their books that enables them to be a regular
issuer in the market, utilising different currencies and maturities that meet
the demand of investors.”
A different definition
But beyond the who and what is the why — in particular why
so many people have worked so hard and passionately to promote this market when
almost everything it has financed could just as easily (and cheaply) have been
financed by the same organisations with other, unlabelled, debt. It is a
question that does not sit easily with many people because it touches on a raw
nerve — additionality.

It is easy to understand why so many people are so devoted
to the sector: they see issuing, arranging or investing in green or social
bonds as helping to make the economy sustainable. Green bonds are a very public
signal that money is being deployed in a green way. “To provide tangible,
quantifiable additionality you need people to act,” says Flensborg. “The green
bond market provides the basis for acting. We are currently seeing the early
results of this activation with new strategies and products being launched.”
But as optimistic as Flensborg is, is the sustainable bond
movement really creating the extra financial resources needed to make a real
difference to, for example, climate change? Is it financing projects or results
that would have not been achieved otherwise? In most cases, the answer is a
simple no.
But, like Flensborg, proponents of the market have faith in
the product, and believe it will become such a big and powerful asset class
that investors will eventually seek out bonds from riskier issuers that might
not otherwise have been able to fund in the bond market. Or that green bonds
will receive subsidies to the benefit of green investment, thereby creating
additionality. But this destiny still lies in the future.
In the meantime, participants are keen to promote and
celebrate a different definition of additionality: awareness. While little has
been financed by labelled bonds that would not otherwise have been with
unlabelled bonds, proponents are quick to point out the product’s mobilising
effect in getting institutions, such as borrowers, switched on to the concept
of sustainability, from C-suite to the shop floor.
“It is quite natural that the first step for an issuer will
be to finance already decided projects but most organisations we meet stress
the positive internal effect and the focus to continue developing new
sustainable projects,” says Langeland. “This also creates a process where the
treasury department considers not only pure financial matters but also
sustainability issues. Our belief is this change of thinking and consideration
of sustainability more broadly in the investment process will have an additionality
effect.”
A new generation
If the World Bank and other supranationals started the
movement that created the sustainable bond market, what — excuse the pun — is
going to sustain it and drive it forward?
Many public sector issuers and fund managers have told
GlobalCapital how much interest students and other millennials have begun to
show in their activities since they embarked on their SRI journeys. The topic
can pack out lecture halls and ensure spikes in job applications.
This is heartening and all very well. But it does not alter
the fact that — despite all the excitement about how the younger generation has
a natural affinity with all things social and environmental and it is they that
will drive real change in investment markets — the sustainable bond market is
still being driven from the top down, by the issuers and fund managers, rather
than from the bottom up, by end investors such as pension funds and, of course,
millennials.
A recent fund dedicated to social assets launched by a UK
fund manager is a case in point. When GlobalCapital asked the manager what had
driven the creation of the new fund, in particular whether it had come about
from an upsurge of interest from the millennial end investor, he rather
sheepishly replied that it was in fact all the fund manager’s idea and there
had been no initial reverse enquiry.
Of course, one reason why millennials have yet to make a big
impact in investment is simply that they are still far away from retiring and
have not saved much yet. So far their influence has mostly been felt on
consumption trends, particularly in the digital economy, artisan coffee shops,
beard conditioners and the smashed avocado market.
But given that they are widely touted as having more
interest in sustainable consumption than other segments of the population it is
surely only a matter of time before they make their mark in capital markets.
In late November, First State Investments published a piece
of research entitled Millennials & Responsible Investment that found an
overwhelming majority, 81%, in a survey were interested in socially responsible
investing — and that they thought friends and colleagues of their age were more
easily convinced than previous generations of the importance of responsible
investments.
More than a quarter (28%) highlighted impact investment —
the ability to have a positive social or environmental impact alongside
financial return — as one of the themes of most interest to them, while 57%
thought the application of ESG could boost long term returns and only 8.5%
believed it would shrink returns.
First State concluded: “As this generational cohort goes
through their working lives and becomes the savers and investors of tomorrow,
responsible investment looks likely to be a significant feature of their thinking
and choices.”
Yet of those surveyed, only one in nine currently invests in
a fund focused on sustainability issues. That proves there are barriers to such
investing — and that there is a large potential for it to grow. Four fifths of
the respondents thought more education was needed and 40% wanted more
information about performance.
Into the mainstream
The green bond market has contributed to a change in ethos,
so that sustainability has become a strategic concern for most organisations
today. It has gone from something that is good to do to something that is
necessary to consider and the only way of doing business. Sustainability has —
to coin a phrase — reached its own tipping point.
In the second half of 2018 barely a day has gone by without
a new initiative or announcement by a government, bank, company or investor
from every corner of the globe about sustainability in one form or another.
In September, California’s governor Jerry Brown signed an
executive order declaring that the state would seek total, economy-wide carbon
neutrality by 2045. A month earlier, its treasurer John Chiang had signed the
Green Bond Pledge, making it the first state in the US to promise to use green
financing to combat climate change.
In October the Seychelles issued the first blue bond of its
kind to support sustainable marine and fisheries projects, while in the same
month, KfW, the EIB and Agence Française de Développement launched a €2bn Clean
Oceans Initiative to finance projects aimed at reducing marine litter and
tipping untreated sewage into the sea.
In November Ma Jun, a member of the People’s Bank of China’s
monetary policy committee, called for altering bank capital rules in China to
give lower risk weights for green assets.
And in December UBI Banca set out on a roadshow to promote a
new sustainable bond framework — despite Italian banks having been largely
absent from the bond market all year. The framework included financing not only
for small and medium-sized enterprises and charities but also religious entities.
It’s taken 10 years, but we can finally say that sustainable bonds are on a
mission from God.
The next 10
But what about the next 10 years? “The challenge now is to
build on the momentum,” says Reichelt. “The Sustainable Development Goals are a
collection of 17 global goals agreed by 193 countries in 2015 that range from
education to health and sustainable cities. They are a helpful framework for
investors and issuers to focus on areas beyond climate and highlight how they
are connected.”
There is great interest in the Sustainable Development Goals
in the financial world, with umpteen banks, investment firms and companies
using them as a framework to help them structure their efforts to further a
healthier and more sustainable economy, through their ordinary business
activities.
The World Benchmarking Alliance, an initiative of Aviva, the Index Initiative and the UN Foundation, is seeking to build a suite of free indices tracking companies’ performance against each of the SDGs, to help investors allocate capital to those most helpful.
For its part, the World Bank is issuing a range of
sustainable development bonds, whose proceeds are not allocated to specific
projects, but which are designed to “engage investors around specific SDGs”.
“For example, a recent initiative is highlighting the
importance of clean water and healthy oceans and the World Bank is engaging
with banks and investors around those challenges,” says Reichelt. “Other topics
of engagement with investors include gender and health, as well as building
sustainable cities and the critical role of building human capital.”
Johanna Köb, head of responsible investment at Zurich
Insurance, expects the themed bond market to continue to expand, and also to
influence the wider capital markets. “We have entered the decade in which the
green bond market, like any teenager, will have decided what they want to be
when they grow up. I’m personally still very excited about the market and think
that on its 20th birthday we will celebrate something that is larger and even
more diverse than today. It will have improved in quality and character, and
taught us how to think about a company’s sustainability features and measure
the impact created. But most importantly, it will have changed the way we see debt
capital markets. There will be an entire family of instruments that are green,
social and sustainable. And we will have learnt to ask for and assess
transparency and ESG features of conventional bonds as well.”
Perhaps most importantly, the idea that finance has a social
purpose has moved from a fringe or fluffy notion to the mainstream — and now is
even becoming part of the legal architecture of markets. Legislation as part of
the European Union’s Sustainable Finance Action Plan will require investors to
disclose how they consider environmental, social and governance issues,
especially climate change. The European Parliament is pushing for even stronger
policies — extending the requirement to banks, and giving investors a duty, not
only to avoid ESG risks to their assets, but to avoid causing negative impacts
in the world.
Strong policies are desperately needed. Even though the
labelled bond market is now into its second decade, with over half a trillion
dollars issued, the problems that it was created to help stem are still getting
worse. At the end of November, on the eve of COP 24 in Katowice, Poland, the
United Nations revealed that CO2 emissions were rising again, the first
increase for four years.
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Green light in the darkness
That the World Bank’s first green bond was launched in the
teeth of the global financial crisis is intriguing and perhaps easy to forget.
It is worth reminding ourselves just how extraordinary this period was.
Volatility had been gradually building since April 2007. But by the time the
bond was launched in November 2008, capital markets were in utter disarray.
September had seen Lehman Brothers collapse and the US
government bail out housing agencies Fannie Mae and Freddie Mac and insurance
group AIG. October brought the collapse of Iceland’s banks, the UK government
spending £50bn to rescue its banking system and central banks slashing interest
rates around the world. These were black days for a debut green bond.
There is no doubt the crisis made planning and execution of
the Skr3.35bn deal harder. But, as Langeland at AP2 points out, in a strange
way, it also helped train minds on the task in hand. “First of all I think the
carnage in the market actually increased focus on longer term sustainability
(and also it felt meaningful to work with these kind of issues), away from
short term profit-maximising business models.
“That said, of course the increased awareness of risk made
the whole process around the bond a bit more cumbersome and time-consuming.
Once it had been issued, the attention was amazing and the ball was rolling.
The foundation for the sustainable bond market had been constructed.”
The attention Langeland describes has been particularly
strong at the investment banks. Many see it as part of their new post-crisis
social responsibility and role in providing and arranging purposeful finance.
Indeed, for many banks, financing solutions for sustainable infrastructure is
now a C-suite concern — a way to promote inclusive capitalism and win back
public approval damaged in the financial crisis and its messy aftermath.
In the last 10 years nearly every bookrunner has promoted
its commitment to sustainability, with many creating specialist teams. “Banks
are good in mirroring the overall trends in society and sustainability is
getting more and more attention — nowadays they almost stumble over themselves
to declare how deeply they are involved in sustainable issues, so it definitely
had an effect,” says Langeland. “Their reputation was not great after the GFC
and for sure they needed some positive impetus to look better in society.”
Banks’ enthusiam has undeniably speeded up the development
of the market, as they have helped to define standards and diversify the issuer
and investment bases. But their growing involvement and the increasing levels
of competition pose risks, too, in particular around taking issuers to the
market that should not be there. “The risk of green-washing relative to the
profits of underwriting is a crucial consideration for the banks,” says
Langeland.