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$1T milestone for green bonds underscores larger fixed-income shifts

Work on standardization is intensifying as more corporations jump in.

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Global green bond issuance shot past the $1 trillion mark in September. Thanks in part to that surge, this year’s issuance is on track to surpass 2019’s record $257.7 billion of issuance.

But the speed at which investors, corporate issuers and underwriters are aligning with the goals of the Paris Agreement and the impact this will have on the overall sustainable bond market will be 2020’s larger story. Green bonds, which represent about 1 to 2 percent of global fixed-income assets, represent the lion’s share of the sustainable bond market.

"Reaching net-zero is not simply reducing emissions and carrying on with the business models of today," said Günther Thallinger, chief investment officer of Allianz and chair of the United Nations-convened Net-Zero Asset Owner Alliance, which in October announced ambitious five-year portfolio decarbonization targets. Alliance members plan to meet their targets by first changing their own practices and then reaching out to various companies to work on changing their businesses.

For Net-Zero Asset Owner Alliance members, which include 30 of the world’s largest investors, to declare "we won’t be able to fulfill our long-term commitments" with uncontrolled climate change is big news, said Nick Robins, professor for sustainable finance at the London School of Economics’ Grantham Research Institute for Climate Change. The bond market should be paying attention because refinancing moments are when fixed-income investors are at their most influential as stewards, he added.

For investors and underwriters, green bonds represent a way to engage with borrowers about their environmental, social and governance (ESG) philosophy. Borrowers, meanwhile, see green bonds as one tool that they can use to advance their sustainability strategy.

Reaching net-zero is not simply reducing emissions and carrying on with the business models of today.

"Issuing the bond was also a way for us to signal to the financial community that our sustainability programs are incorporated into our strategy," said Roberta Barbieri, vice president for global sustainability at PepsiCo, which last October became one of the first corporations from the food and beverage industry to issue a green bond. The net proceeds of PepsiCo’s $1 billion green bond are being allocated to programs aimed at driving greenhouse gas reductions.  

The arrival of household names — Pepsi, Verizon and Apple — to the green bond market broadens the sector coverage for Paris-aligned investors. Until about a year ago, utilities, banks and real estate companies dominated the sector.

Currently, renewable energy-related green bonds represent about half of the sector’s issuances. That makes sense because the ultimate impact of most green bonds is a reduction in carbon emissions, said Marilyn Ceci, global head of ESG debt capital markets at JPMorgan Chase.

According to Steven Nichols, head of ESG capital markets for the Americas at BofA Securities, the surge in corporate ESG issuance is reflective of the increased buy- and sell-side focus on and awareness of ESG issues.

Amid that heightened focus, trustees of the International Financial Reporting Standards Foundation, set up to develop a single set of globally accepted accounting standards, are seeking input on the need for global sustainability standards and the role that the foundation could play a role in the development of such standards.

"There is urgent demand for consistency and comparability in sustainability reporting, especially for climate-related information," the Task Force on Climate-Related Financial Disclosures (TCFD) said in its 2020 status report released last week. 

And last Thursday, the New York State Department of Financial Services, which recently joined the NFGS, sent out a letter saying it expects state-regulated financial institutions to start developing approaches to climate-related financial risk disclosure; it suggested engaging with the TCFD’s disclosure recommendations or other similar initiatives. It also said that it expects the financial institutions that it regulates to incorporate climate change-related financial risk into their internal governance frameworks, risk management processes and business strategies.

According to the report, investor demand for companies to report information in line with TCFD recommendations has been growing dramatically. Additionally, central banks and supervisors — through the Network for Greening the Financial System — have encouraged companies issuing public debt or equity to disclose in line with the TCFD recommendations, the report noted. 

A September to remember

September’s green bond issuance surge was aided by low interest rates, issuers returning to market after several COVID-related quiet months and a desire to issue before U.S. election-related volatility comes into play, but Germany and Sweden’s inaugural green bond transactions gave the market its biggest boost. Germany’s Triple-A rated, 10-year $7.59 billion sovereign green bond alone represented half of September’s issuance.

On arrival, Germany’s issuance became the largest green bond issuance this year. And in a bid to increase transparency in the green bond market, when Germany’s Federal Ministry of Finance issued its first green bond, it also issued a conventional bond that had the same coupon and maturity.

"[Before that] there seemed to be a pricing advantage for green bonds, but it was hard to identify [outside of the secondary market] because you never had an issuer doing two transactions at the same time," said Andrew Karp, head of global investment-grade capital markets at BofA Securities.

The fact that Germany’s green bond is trading a couple of basis points tighter than its conventional bond twin indicates strong investor appetite. For corporate issuers, it also signals a potential cost benefit to issuing green debt.

Issuing the bond was also a way for us to signal to the financial community that our sustainability programs are incorporated into our strategy.

Despite the absence of a favorable regulatory environment, U.S. corporate issuance represents a sizeable portion of the green bond market. If the Biden/Harris presidential ticket — which is campaigning on rejoining the Paris Agreement — wins, U.S. corporate green bond issuance likely will grow at a faster clip. "But the rules of the market will likely be set in the EU and Beijing," Robins said.

The European Commission is expected to introduce its Green Bond Standard next year, and disclosures against the EU taxonomy or sustainable activities also will start to become mandatory for EU investors and corporates in 2021. The EU’s taxonomy regulation involves establishing the criteria for determining whether an activity qualifies as "sustainable."

China, meanwhile, recently has proposed changing its green bond standards so that they more closely align with international ones. This could boost international investors’ interest in its green bonds, Robins said.

A dress rehearsal for climate change 

The COVID-19 pandemic has revealed the depth of the world’s interconnectedness. "The pandemic has [also] demonstrated that the wallet and the will is available to react to an acute situation," said Ketish Pothalingam, executive vice president and portfolio manager at PIMCO.

"In many respects [climate change] is far more threatening to our longer-term outcomes than the pandemic is," he added, underscoring that he does not want to downplay the impact of the pandemic. 

As part of its COVID-19 recovery package, the EU plans to sell $263 billion of green bonds and $117 billion of social bonds.

According to Matthew Kuchtyak, assistant vice president on Moody's Investors Service’s ESG team, the EU’s plans to issue up to $117 billion of social bonds would nearly double the total size of the social bond market globally, demonstrating that the European market is at the forefront of sustainable finance developments.

In mid-October, the EU launched a two-tranche $19.85 billion inaugural social bond under SURE, a COVID relief program designed to protect jobs and keep people in work. The bond, which included a 10-year $11.7 billion issuance and a 20-year $8.17 billion issuance, was more than 13 times oversubscribed.

Some market participants say Europe’s sovereign green and social bond issuances should help with standardization around impact reports and key performance indicators (KPIs). Others added they think these issuances will help establish euro-denominated green and social yield curves, which can provide corporates with a comparative pricing for conventional bonds versus green bonds. "Credibility comes from standardization," Thallinger said.

On the horizon

In the coming months, JPMorgan and BoA Securities both expect to see continued thematic growth in social bonds, sustainability bonds and sustainability-linked bonds and increased investor attention to ESG-related supply chain issues.

"Supply chains and their sustainable procurement is an important issue for investors. ... Corporates are in the driver’s seat and can demand that their supply chains deliver certified sourced goods," JPMorgan’s Ceci added.

Whereas sustainability bonds proceeds can be used to finance a combination of green and social projects, sustainability-linked bonds are linked to KPIs and their coupons are dependent on whether a reference ESG target — or a set of ESG targets — is met.

Because sustainability-linked bonds are holistic in nature, they can also address the "G" in ESG, said Nicholas Pfaff, head of sustainable finance at the International Capital Market Association (ICMA).

Credibility comes from standardization.

By trying to lower emissions at the firm level, sustainability-linked bonds tackle some issues identified in a recent Bank for International Settlements’ report that explored the case for a firm-wide rating based on carbon intensity (emissions relative to revenue) as a way to reduce corporate carbon emissions.

According to Robins, sustainability-linked bonds can pack a bigger punch than a firm-level rating based on carbon intensity. "Because they [can] connect green and social outcomes with the cost of capital, generating financial incentives for delivery," he explained.

Ultimately, heavy emitters, largely absent from the green bond market, need a pathway to issue green bonds so that they can finance a transition to a low-carbon economy, said Heather Lang, executive director of sustainable finance solutions at Sustainalytics. "It is time to broaden the tent," she added, noting sustainable bond markets offer an opportunity for capital markets to assist heavy emitters as they transition to lower emissions compatible with overarching climate goals.

In a whitepaper released in September, the Climate Bonds Initiative and Credit Suisse explored what financing a credible brown to green transition could entail. ICMA plans to release a climate transition finance handbook by year end. 

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