SRI wave makes non-issuers, even sovereigns, the outliers
The supranational and agency bond market’s love affair with green and socially themed bonds has reached a new intensity. Most large issuers now have programmes and they are deepening them with new assets. Government issuance is less advanced, but will soon overtake, as sovereigns copy the high profile, signalling deals of their neighbours. Jon Hay reports
On June 20, Freddie Mac, the US mortgage agency, issued a $435m securitization of the kind it calls K Certificates, which it sells several times a month. This, however, was different — it was its first green bond.
Freddie was joining sister agency Fannie Mae, whose green bond issuance exploded in 2017, making it in a year the world’s biggest green issuer.
Fannie now has $56bn of the paper outstanding, backed by special loans it makes to owners of blocks of flats that meet green building standards, or where the owner invests to reduce energy or water use. Its issuance is emblematic of the huge clout of public sector balance sheets to finance green alterations to the economy.
Most of this, of course, does not appear in the green bond market. Freddie Mac, for example, has underwritten $45bn of green debt since 2016, without issuing a green bond.
Nevertheless, the trend to socially responsible investment-themed debt issuance has swept the supranational and agency debt sector. Of Dealogic’s top 50 issuers since 1980, 32 have now issued SRI bonds.
Freddie’s debut is unusual. As Pierre Blandin, head of sovereign, supranational and agency debt capital markets at Crédit Agricole CIB in London, says, there have been very few new issuers in 2019. “Most of them have already tapped this market — there are not many missing,” he says.
Some big agencies remain absent — Federal Home Loan Banks, Canada Housing Trust and Caisse d’Amortissement de la Dette Sociale.
But Blandin is not losing sleep striving to bring them to market. “There is no one that would strike me as being the missing link,” he says. “The obvious targets have issued.”
This does not mean the market has stopped growing. After a dip last year, supra and agency issuance hit $30bn in the first half of 2019, putting it on course to far exceed 2017’s record of $43bn by the end of the year.
Two forces will drive supra and agency SRI issuance. The first is the issuers’ balance sheets expanding.
Société du Grand Paris, which first appeared in October, has pumped out six deals totalling €3.2bn this year. This is just the beginning: the state company plans to spend €38bn building 200km of underground rail lines and 68 stations connecting the outskirts of Paris.
The second is public sector issuers widening the assets they classify as eligible for SRI bond programmes.
Some are broadening an existing programme. In May, KfW revised its Green Bond Framework, to include energy-efficient construction loans. Until then, its €14.5bn of green bonds had only financed renewable energy.
The bigger asset pool has allowed KfW to offer green bonds at its full benchmark size of €3bn.
Petra Wehlert, head of capital markets, said in May that KfW would increase its green bond issuance from €1.6bn last year to €5bn-€6bn this, out of an €80bn funding programme.
A few days later, KfW’s first €3bn green bond attracted €9bn of demand and was priced 1bp through its conventional bond curve, or 3.5bp above its green curve.
Other SSAs are taking a different route: launching a second strand of SRI bonds.
The European Investment Bank, having issued Climate Awareness Bonds since 2007 to finance renewable energy and energy efficiency loans, last September inaugurated Sustainability Awareness Bonds, referencing a wider range of environmental and social projects. It began with water projects, including clean water supply and flood protection.
France’s Société de Financement Local, which finances local authorities and export contracts, issued its first social bond in February. The covered bond raised €1bn to lend to French public hospitals. “We will be regularly issuing social bonds, and are setting up our green bond framework,” says Ralf Berninger, head of investor relations at the agency in Issy-les-Moulineaux. “It will be much larger in scope, with a wider range of projects.”
The programme will finance local government, which makes 80% of French public investments in environmental protection, including public transport, green buildings and water and waste management.
Sovereign tipping point
However, the really big prizes for SRI bond bankers and investors are sovereign issuers. Until 2018, they could still be seen as isolated beacons. But with the addition this year of the Netherlands, Hong Kong, South Korea and Chile, the tipping point has been passed. Non-issuers look out of line.
“With every year more new sovereigns are coming to the market, and we know it’s not over,” says Stéphane Marciel, head of sustainable bonds at Société Générale in Paris. “Several other sovereigns are looking at it.”
Sweden’s long-prepared deal has not appeared, perhaps because its borrowing requirement is so low. But the Spanish Treasury declared in February it was considering issuing ESG bonds to finance its €47bn plan to decarbonise the economy by 2050.
The main point is to draw attention to green activities and encourage others to follow suit.
“We did this issue to support the development of the green market,” says Eric Ligthart, project lead for green bonds at the Dutch State Treasury Agency, which made its €6bn debut in May. “There have been financial issuers, utilities — what we’d like to see is that other players like corporates would issue green bonds as well.”
But there can be more concrete benefits, too. In June, Chile’s funding officials were thrilled with its $1.42bn and €861m first green bonds.
ESG investors that had never bought Chilean debt before piled in — 40 bought the dollar bond and 64 the euro. “Tapping these investors gives us lower yields,” says Andrés Pérez, head of international finance at the Ministry of Finance.
The first issue got Chile’s tightest ever 30 year yield, the second came 5bp-10bp through its curve.
“Chile tends to be a leader in the market, so I wouldn’t be surprised to see other sovereigns taking a close look,” says Gordon Kingsley, a Latin American debt capital markets banker at Crédit Agricole CIB in New York, who worked on the euro deal.
Sean Kidney, chief executive of the Climate Bonds Initiative, is convinced the UK will issue, as its Green Finance Taskforce recommended in 2018, though it may take a year or two.
Even Germany, mighty in the debt market and jealous of the purity of its Bund curve, is studying the feasibility of green or sustainable bond issuance.
It is considering an idea, put forward by Danish funding officials, of issuing bonds with green labels that could be stripped off and traded separately, with their own ISIN codes, but no cashflows. The point is to avoid having to issue sub-benchmark, less liquid green bonds.
Some market participants admire this as a clever notion, but it seems unlikely to be implemented. Many investors cherish the idea that their specific money is going to green projects and hardly any are keen to put a visible price on the green halo alone.
Germany may, instead, gather its forces and issue a large green Bund.
The Finanzagentur has syndicated dollar bonds or inflation-linked notes, but if it went for maximum size with a green deal, it might follow the Netherlands and auction it.
The Netherlands used its Dutch Direct Auction method, a hybrid of auction and bookbuild. This precludes exercising name-by-name discretion in allocations, yet one of the main points of issuing a green bond is to refresh one’s investor base by allocating to green investors.
The DSTA found a novel solution. The DDA already involves classifying investors, to balance allocations to trading accounts and real money. Before the green deal, investors were invited to qualify as green investors, earning a 10% larger allocation, by submitting a form, signed by their compliance officers, declaring that they met at least three of four criteria.
These were having a dedicated ESG analysis team; following specific ESG requirements when investing in green bonds; intending to buy the deal for a specific green bond fund or target; and committing to report at least annually on its green bond investments.
Ligthart says the scheme was meant to gather “not only the pure green players, but also larger players that have a green future in mind. We wanted to give incentives to investors that are in the process of going to a more sustainable portfolio.”
With its new benchmarks, KfW is also using systematic criteria to categorise green investors, though this is still done manually in the bookbuild.
On the grid
But a much greater move towards order and rules is coming on the asset side of the instrument. The European Union is legislating a Taxonomy of Sustainable Economic Activities. The first partial draft, of 414 pages, was published in June.
It has many fans. Ligthart suspects what is holding companies back from issuing green bonds is the risk of being accused of greenwashing. “The EU plans will give more comfort to the market as to what is to be considered an ambitious enough level for a corporate to issue green,” he says.
Marciel believes the Taxonomy and accompanying Green Bond Standard will have implications for all issuers. “The Taxonomy clarifies a lot of points, and opens the market up to quite a lot of new sectors,” he says. “There are brand new activities like chemicals, steel, aluminium, some kinds of manufacturing, which really opens up new possibilities.”
SSAs could take advantage of this by adding projects in these industries to their SRI bond eligible assets.
“Everybody continues to contend that the Taxonomy is too complex,” says Aldo Romani, head of sustainable funding at the EIB in Luxembourg and one of the Taxonomy’s original begetters. “I find it the opposite. It is just conceived as a simplification instrument that allows the market to express its judgement.”
More important than the thresholds used to decide what is in or out, he argues, is the structure of the Taxonomy: a grid of environmental objectives and the means used to achieve them, which should enable players to compare claims to greenness. SSAs and companies will reclassify their green activities according to the Taxonomy, Romani says. “Things are becoming sharper, clearer.”