ROUNDTABLE: Finance finds the right direction: now to reach the right speed
In the past two years, environmental, social and governance matters, especially climate change, have gone from a fringe issue in capital markets to — almost — the main issue. Banks, investors, companies and governments have shouldered the responsibility of helping move the economy to net zero emissions in 30 years. That duty has joined the fiduciary obligation to make money for customers and shareholders that have been the markets’ main motivation in the past.
The destination is agreed — what remain to be decided are the route and the pace.
GlobalCapital and Morgan Stanley gathered together three leading sustainable finance issuers and four prominent investors in early June to discuss how capital can best be engaged to drive the transition.
They pointed out the urgency of the transition to net zero, but also the need to build robust strategies based on evidence. Standards are needed for how fast industries are decarbonising. Taxonomies such as that from the EU can help, by giving market participants a common language, but are not the whole answer.
Meanwhile, investors themselves are being regulated, in ways that are likely to steer and deepen their engagement with ESG issues, such as the Sustainable Finance Disclosure Regulation.
Along the way, much use will be made of sustainable finance instruments — the speakers discussed the relative merits of green and social use of proceeds bonds and sustainability-linked structures.
Participants in the roundtable were:
Alban de Faÿ, credit portfolio manager and head of fixed income SRI processes, Amundi
Bernard Descreux, group treasurer, Electricité de France
Joshua Kendall, head of responsible investment research and stewardship, Insight Investment
Cristina Lacaci, head of ESG structuring, global capital markets, Morgan Stanley
Samuel Mary, senior vice-president and ESG research analyst, Pimco
Aldo Romani, head of sustainability funding, European Investment Bank
Laure Villepelet, head of ESG and CSR, Tikehau Capital
Bodo Winkler-Viti, head of funding and investor relations, Berlin Hyp
Moderator: Jon Hay, GlobalCapital
GlobalCapital: The Paris Agreement commits the financial sector to striving to limit global warming to 1.5°C. Is the financial industry doing enough?
Alban de Faÿ, Amundi: It is a hot topic for us. As an asset manager, we have a responsibility to follow the various agreements, meaning that we make sure financial flows are going in the right direction and build strategies with attractive financial returns to ensure that investors will be interested in investing.
We may be asked by a regulator to push companies to move forward and sometimes it is quite complicated when companies do not publish key data — for example, on carbon intensity. The most carbon-intensive sectors do it, but for other sectors it is not the case. We do not always have the information we need to track companies’ environmental commitment, which is why engagement is a core component of this trajectory.
Joshua Kendall, Insight Investment: My interpretation of the Paris Agreement is that it is for governments to meet the 1.5°C target. What has followed is separate initiatives for asset owners and asset managers to get behind those overarching goals, which the financial community is clearly supportive of.
Ultimately, our role in society as a financial industry is to service our clients and broader society to align with their financial needs for retirement many years into the future. So clearly we have a broader responsibility than just making financial returns.
Do we have the right information to distinguish between leaders and laggards and guide us towards the most appropriate investment decision? We are well short of that.
Fortunately, the European Union has recognised that and launched initiatives for greater transparency. That information can guide portfolio construction, engagement with issuers and help investors make better informed decisions.
We know what our responsibility should be, what our clients are expecting, but there is a big gap between what is realistic and possible and what clients or regulators might be looking to achieve in five, 20, 30 years’ time.
Samuel Mary, Pimco: There is a very strong momentum in investors’ commitments and engagement on climate change. So the direction of travel is clear.
The questions are more about the pace, the coverage, the real world impact and challenges of implementation.
If we look at the pace and the coverage, in the past two years there has been particular interest and signs of acceleration — illustrated by the momentum for net zero pledges.
At Pimco, we have been focused on helping our clients and developing a range of proprietary tools to help align portfolios with the net zero pathway. We have also been working with emerging industry standards such as the Net Zero Investment Framework.
This effort can always be broadened and accelerated. In fixed income, we want to cover all the asset classes, not only corporates and sovereign.
What is interesting is that the discussion has partly shifted from the commitments to their actual impact — evaluating what measures are most effective and can amplify the positive impact of the finance industry.
Laure Villepelet, Tikehau Capital: The finance industry is clearly not doing enough yet and now there is an urgency. We are very optimistic at Tikehau Capital because recently we have been getting more reports supporting us to drive investments towards where change is needed — increasing renewable capacity, energy efficiency and low carbon mobility.
There are a number of pathways and frameworks, on top of the International Energy Agency’s Net Zero by 2050 report. The EU Taxonomy is also a great tool that we are already using and applying to investment.
So we have the means to develop strategies based on robust evidence. As investors we need to be pragmatic and not wait until we get the perfect data but start now.
We launched a private equity fund dedicated to the energy transition in late 2018. It was a success, with more than €1bn raised, so we want to really pursue this, developing funds that will help decarbonise our economic environment.
We need to partner with mid-cap companies which are offering products and services that may not only contribute directly but help them focus on where they have a positive impact, so that at some point we can contribute to reaching this net zero target.
For example, we have been investing in a company which does building renovation, maintenance and repairs including insulation and efficient boilers. We support them in structuring their energy efficiency offer so they can benefit from the market and maximise their impact.
GlobalCapital: Cristina, do you think the investment banking industry is doing enough yet?
Cristina Lacaci, Morgan Stanley: In the last few months, we’ve all taken quite significant measures. One of the key steps has been the establishment of net zero financed emissions targets by 2050.
The next step for the industry is to agree on the standards. What will be the methodology? Can all activities be included? The second is to establish interim targets that will help us meet those longer-term objectives.
The final ingredient is to make sure we support our clients in this transition. A lot of steps have been taken in the last few months but it is just the starting point of a journey to help our clients meet these targets.
GlobalCapital: Bernard, do you feel the financial industry is helping you on your journey to sustainability? Are you dragging it with you, or is it pulling you from in front?
Bernard Descreux, EDF: It’s not pulling us too much — it gives us an incentive to do so. EDF is well advanced in its path towards carbon neutrality in 2050, but the pathway to go there gives the opportunity of exchanges with investors.
We are not very fond of sustainability-linked bonds, but on our credit lines we like to have commitments that we share with the banks.
What is disappointing is that we would welcome bilateral commitments, step-ups and step-downs, in the commission or in the yield on swaps, that would affect the company as well as the bank, given their relative ESG performance.
When we talk with investors, they want transparency on the use of proceeds. That is why we prefer to issue use of proceeds bonds. They have a fiduciary duty to display what they are doing on financing the energy transition, so it’s important for them to see how their money is deployed and how it serves the transition, and the just transition also.
Bodo Winkler-Viti, Berlin Hyp: Hardly a day passes when one bank or another does not issue a green bond, a sustainability-linked bond, a social bond. Especially in the financial industry, it was not always like this — in some of these segments we banks have been slower than others.
The direction is the right one. The question is whether we should speed up a little bit more. Cristina mentioned the net zero emission commitments of banks for 2050. These commitments are a very good sign and lead in the right direction.
However, you really have to be aware of how to get there as a bank, how to assess your business. For us, only doing one business — commercial real estate lending — that is much easier than for more complex banks which operate in many different sectors.
We have defined our own journey with interim targets, how to get to carbon neutrality, but for the wider financial industry this is a more difficult question. But we all need to develop faster in that direction because the number of years until 2050 gets shorter every year by one year. There are not so many left.
GlobalCapital: Aldo, everybody in the financial sector has their eyes now focused on net zero in 2050, but as Cristina and Bodo have mentioned, setting interim targets is very important. Is it possible to align the interim targets of issuers and investors, or is everybody still confused about that?
Aldo Romani, European Investment Bank: A lot of confusion still exists. Much more could be done if there were more clarity as to what needs to be pursued.
All the steps by the Commission in the past few years have led to a clarification of certain core principles that in my view need to be reiterated.
First of all, what counts is not the financial instrument you use but the sustainability of the economic activities you finance.
Second, you must establish a shared set of definitions that permit fair competition among market participants across jurisdictions — national regulators should not be able to determine by themselves what is green or sustainable.
Most importantly, also, this should apply vertically along the investment chain, because investors must speak the same language as intermediaries that funnel investor funds.
This is the sense of the EU Taxonomy Regulation that came into force in July last year.
If you take the EIB as an example, as part of our climate bank roadmap, we will increase to at least 50% the share of green finance in our new lending by 2025. We will measure this using the Taxonomy.
We will be able to reflect this in capital markets by issuing climate and sustainability awareness bonds, which we plan to align with the EU Green Bond Standard.
The conditions are there for markets to become more than just providers of capital. They can really become an instrument of strategic knowledge for society by finding out where capital should be best deployed for the sustainable development of the real economy.
GlobalCapital: That is a lofty aim! I would like to ask the investors: the financial world is now striving to limit climate change, which is obviously a focus on impact rather than risk and return. Does that mean the traditional concept of an investor’s fiduciary duty has changed?
Kendall, Insight: I might dispute the idea that managing climate change issues is about impact. I would see it as being central to risk management.
In 2017 we built a climate risk model to identify issuers that are going to be more vulnerable to that transition, because we believe climate issues that are not managed are a credit risk at their heart.
But clearly, the movement of green bonds is creating great opportunities for impact to sit alongside risk management.
There doesn’t appear to be a fundamental disconnect between managing climate risk issues and fiduciary responsibility, neither do I believe that the concept has changed.
What we are starting to see from legal experts is more clarity that this is compatible with your fiduciary responsibilities. By considering climate risk issues you are aligning with your responsibilities to manage the issues associated with climate change.
Where I think there is going to be more need for debate is the question of whether impact creating positive change is compatible with fiduciary responsibility.
What we need over the next few years is more academic research and more regulatory input into how much of a positive change you can incorporate into your portfolio management and asset allocation, given issues such as the availability of impact opportunities. The green bond market is still significantly smaller than it needs to be for most institutional investors.
The other issue is how do you define impact? We’ve seen some more direction from the EU but there are still huge amounts of disagreement on that.
So we are well short of being in a position where we can say impact is aligned with fiduciary responsibility, but wide agreement that climate change is a necessary component of fiduciary responsibility.
Lacaci, Morgan Stanley: I have a question for the investors: are there any situations when you need to make a decision between impact and risk-returns, and what do you do in those cases?
Kendall, Insight: We are getting more clarity from clients where impact is a core part of their objectives, but that is the exception. For most clients it is about maximising the financial returns in an active portfolio, or in a more stable long-term portfolio.
With an oil and gas bond, you have got to be thinking ‘in 10 years I will have strong visibility, in 100 years I will have less visibility’. For a long-term portfolio the climate risks are going to be real and therefore it is not the sort of instrument you would want to be holding; but for more active positions, it is much less relevant to think about them.
If you have a sustainability mandate, or if a mandate aligns with the Article 8 or Article 9 guidelines from the EU Sustainable Finance Disclosure Regulation, that changes the very nature of what issues are important to you. You should be looking at sustainability metrics. That is going to be relatively new for many portfolio managers because it is not a natural part of how portfolios are constructed.
Once we create a system to align with Article 8 and Article 9, these issues have to be routinely considered. Then I think we will start to see a greater change in how the market considers these factors on a consistent basis.
GlobalCapital: There can be a distinction between impact and risk and return and they can occasionally be in competition or in conflict.
We ought to think about the idea of the ‘universal owner’, as well. You can have a portfolio where you think about the climate risk to the assets in that portfolio and decide they are safe, but this could have bad effects on the wider world and economy which would be felt in your other assets.
De Faÿ, Amundi: Our fiduciary duty is still the same. We have to buy bonds at fair value and that’s about credit risk. Clearly credit risk is also moving, taking into account more and more long-term risks, and it is the role of a regular credit agency to monitor that.
We have a dedicated strategy of impact investing, in which we manage both financial and environmental impact, where impact could be seen as a return.
If you want to improve your returns, your impact, you have to take some risk. So, do you want to finance a wind farm in the Netherlands or an emerging market?
Clearly, if you finance a wind farm in an emerging market, you will have a higher environmental impact but you may have also a higher credit risk — though sometimes you can do it through bonds issued by a European bank.
From time to time, you have to make choices. Evidently, our first responsibility is our fiduciary duty, but today it is not enough. You also have to be a responsible investor and be sure that in the activities you finance you take full responsibility and consider the impact of your investment on society for the long term.
That’s why, at Amundi, we have a 100% ESG integrated strategy. We want to take into account the impact of our investment on society, but we are also working to better understand how a company is moving around climate. So we integrate new impact indicators like temperature ratings, carbon reduction targets, Science-Based Targets and so on.
We try to combine all the dimensions. Bernard mentioned the just transition — clearly, when we are financing the energy transition we want to be sure that it is socially acceptable.
We do not want to focus on one theme. Behind some pure dedicated themes like the environment, you may also have social issues which could be very important.
GlobalCapital: Green and social bonds have developed very well over 14 years, but what is their future, as the whole economy starts to become much greener?
And how do they interact with sustainability-linked bonds? Is one better than the other?
Descreux, EDF: Both markets will co-exist because they are complementary. All sectors and all companies are not at the same level in their pathways towards carbon neutrality. It can come from history; very often it comes from physical constraints on certain industry processes.
In the case of electricity, EDF has the possibility to be in advance in that transition, but that means we have very large investment to make in low carbon assets. So it is useful for us to issue use of proceeds bonds. Investors like to target their investments and make sure they are going in the right boxes.
Companies that are changing their business models, that are in transition, cannot give today very high performance indicators, but they may have a strategy and can give objectives that show their commitment to change.
For them, the sustainability-linked bond market is the perfect tool to tell investors their commitments. My guess is that, progressively, they will be able to change their issuance from these SL bonds towards use of proceeds bonds.
I think the strategy of the European Commission will favour use of proceeds bonds, as they will create scarcity for these bonds and this will help issuers to lower their cost of funding.
GlobalCapital: Berlin Hyp has been an enthusiastic green bond issuer for some time and has recently introduced a sustainability-linked bond. So, Bodo, I’m guessing you don’t think the order of transition is necessarily from SLB to use of proceeds?
Winkler-Viti, Berlin Hyp: No, I don’t agree with Bernard there. It is definitely not like this in our case.
We issued 13 benchmark green bonds before we issued our first sustainability-linked bond.
Both instruments follow totally different concepts. I use my green bonds to refinance a very specific portfolio at Berlin Hyp. I use the sustainability-linked bond to demonstrate to investors and other market participants what the bank’s ambitious goals are as a whole, and I share our way to get there.
I think that is something totally different from a use of proceeds bond. It is not better and not worse than a use of proceeds bond. The functioning is simply different.
As a fully capital market-funded bank, we are not able today to issue every debenture as a green use of proceeds bond. There is other business that needs to be done as well.
The point of transition has already been mentioned. If we finance the acquisition of a non-green building today, that is not bad per se if the bank gives, after that advice, the financial means to do a proper renovation of that building. But, for that reason, it is not possible to have only a green portfolio.
GlobalCapital: Aldo, you mentioned that the EIB is going to move towards 50% green lending, so that will mean a lot more green bonds, I expect, but what do you think of Bodo’s point that for the other assets you can also use the capital markets to demonstrate your sustainability commitments. Could the EIB do sustainability-linked bonds for its ordinary bonds?
Romani, EIB: I am convinced that the transparency use of proceeds bonds provide on the underlying assets is of paramount importance in the overall design of transforming the economy on to a sustainable path.
Sustainability-linked bonds can be meaningful in an issuer’s communications strategy, as they clarify the attention it dedicates to specific objectives.
We have a focus on environmental protection, a whole set of objectives, and we finance our activities also via general purpose bonds.
I agree that there should not be an opposition or a contrast between the instruments. They serve different purposes and as long as these purposes are clear, it is perfectly fine to use them. It is up to investors to decide whether they make sense or they don’t.
It seems that investors also give these instruments a role in their dialogue with issuers. From our point of view, in terms of the strategy the bank has adopted, use of proceeds bonds are a priority.
GlobalCapital: Laure, as an investor, how do you evaluate these two structures? If you’re forming portfolios, can you use the two together?
Villepelet, Tikehau: On top of being an investor, we are also an issuer. Tikehau Capital recently issued its first sustainable bond. It is a use of proceeds bond, but we are also considering sustainability-linked loans at our level.