Beyond Green Bonds

Have you watched Our Planet?

Netflix’s flagship nature documentary has everyone talking. This time, the producers chose to drop the sentimentality of their predecessors, and present an unequivocal message about the adverse effects of climate change. The show’s release is occurring against a backdrop of ongoing protests in London, with the Extinction Rebellion looking to pressure the British government into doing more to address climate change. And only this week, 16-year old activist Greta Thunberg took her climate message to the Houses of Parliament, telling politicians how our “future has been sold so that a small number of people can make unimaginable amounts of money.”

The discourse (and discord) around climate change has been raging for years. But it seems to have reached a tipping point in the same way ocean plastics did a couple of years ago (linked to another nature documentary, Blue Planet II).

As issuers, dealers, investors and technologists what does that mean for us? What impact will the shifting political context have on capital markets? These questions are too ambitious to answer in a blog post, but they are worth considering nonetheless.

Two years ago I blogged about green bonds, arguing that while much progress has been made since the launch of EIB’s groundbreaking Climate Awareness Bond in 2007, it would take time for this issuance category to mature. So, where are we now?

2018 saw $167.3bn in green bond issuance. 1,543 green bonds were issued from 320 issuers. There are now 625 originators of green bonds in 44 countries. These names straddle the issuer spectrum, from sovereign, agencies and supras to corporates and financials.

Looking at the wider picture, there’s bad news and good. The bad news is that green bonds still account for only 1% of total issuance. The good news is that green bonds still account for only 1% of total bond issuance! In other words, whilst the market has been slow to develop, it has massive potential. There remains a huge opportunity to grow issuance, unlocking a valuable source of funding for issuers and helping investors to diversify their fixed-income exposure.

The key to achieving this is retail. Until now, green bonds have really been the domain of pension and insurance funds with ESG mandates. But the underlying political landscape is changing things by creating an environment in which ESG products are becoming relevant to a whole new audience. Indeed, around 20 specialist ETFs and mutual funds are now active in the space, with $2.8 billion in green assets. But here’s the kicker – half of those have come online in the past two years. Growth is happening fast.

The rise of retail in the green bonds space signals a change in the way that issuers and investors do business. ETFs and mutual funds are much more likely to be active traders in the securities (unlike pension investors who typically buy to maturity). As these bonds start to be traded more frequently, this will raise awareness, accessibility and liquidity in a positive feedback loop that should spur growth in the sector.

I’m a big believer in green bonds. But they’re not a panacea, as highlighted by this excellent blog post from the World Bank. The cost of reporting is not insignificant. And there are, in fact, many good reasons why carving out financing for a specific project is irrelevant at best and detrimental at worst.

But, if we look beyond green bonds, we see that the ESG financial product mix is expanding, and this is very exciting. For example, ESG loans link interest payments to improvements in sustainability, but unlike green bonds they don’t require borrowers to use proceeds for a specific purpose. They provide issuers with tons of flexibility, enabling companies who don’t have “green projects” but who want to be greener.

ING issued the first sustainability-linked loan, totalling $1.2 billion, to Philips in April 2017, and the market has been growing strongly since then, with $36.4 billion of issuance in 2018. Ultimately, ESG loans may have an even bigger impact than classical green bonds, as they open up the market to a much larger pool of issuers. These include corporates and other borrowers who aren’t directly in the green energy business, but who can still be incentivised to improve their own operations and carbon footprint. And as lenders and investors are getting better at assessing climate related risks to their portfolios, addressing climate change may move beyond just an exercise in corporate social responsibility (CSR), and could finally directly impact a borrower’s bottom line.

For our planet’s sake, here’s hoping.