By Harriet Evans, Investment Analyst at Church House Investment Management
There’s no doubting the increased drive in demand for green, sustainable and social impact bonds of late. It stems from various sources, including an increased awareness of the urgency of climate change, the widespread regulatory push, where large pension funds are now having to consider ESG in their investment decisions, as well as the appetite from a new, younger generation of investors. This has increased the importance of generating returns in a sustainable manner and led to a rise in demand across the investor base.
According to Barclays, global corporate ESG bond supply in 2021 has already outpaced last year’s, with a total issuance of $235 billion in H1 2021 alone versus $188 billion in the full year 2020. Notably, the strong growth of green, sustainability and sustainability-linked bonds has outstripped that of social bonds, whose growth has been somewhat lagging in comparison. The drive in growth for green bond issuance has been led by the Banking and REIT sector, closely followed by the Utilities sector, aligning themselves to their transition plans. Sustainability bonds have been primarily issued by financial institutions, such as banks, predominantly in dollars. Sustainability-linked bond issuance, a more flexible form of issuance which attracts companies who previously would have struggled to access this market, has also significantly picked up. These bonds create an alternative method for companies to demonstrate their commitment and accountability to sustainable initiatives, with the lion’s share being issued by the industrial sector.
In the first half of 2021, almost 25% of euro investment grade debt issuance has a link to ESG (in volume terms), a trend on the rise, accounting for only 9% last year. This compares to 22% for sterling investment grade issuance and 17% euro higher-yield debt. While ESG-labelled bonds were typically issued by companies with strong credit ratings, we are beginning to see more BBB and higher-yield bonds participating in this issuance.
Demand for green bonds has soared, with governments and corporates scrambling to make use of the so-called ‘greenium’, where they are able to issue debt at lower cost. An example of this is Germany’s debut green government bond, which has traded at a premium to its non-green equivalent since its issue in September 2020. Closer to home, the UK is set to issue £15 billion of green Gilts this year with capital being allocated to green investments, such as wind and hydrogen energy, in an effort to help the UK hit its 2050 net zero target. Other European countries have also issued green bonds and it is encouraging that governments, which account for 75% of global GDP, have pledged to net zero targets, according to Bloomberg.
Remaining conscious of the opportunity for ‘greenwashing’ is important. There is little doubt of the awareness and progress made by many companies and governments in their efforts to avert climate change. However, having an action plan with the setting of short-term targets, alongside the longer-term net-zero goal, is vital. The first priority should be investment into sustainable solutions, with carbon credits used where all other options have been exhausted. During the pandemic, fossil fuels received more than half of the total support for energy-intensive sectors:
A key concern is that while these green bonds are being issued in an effort to combat climate change, the value of bonds and loans issued to finance the fossil fuel industry has been markedly higher. Since the signing of the Paris Agreement in 2016, global banks have underwritten over $3.6 trillion in bonds and loans for the fossil fuel industry, with coal financing continuing to garner support from China’s banks. At the same time, around $1.3 trillion of green bonds and loans to finance environmentally positive projects have been issued. On a more hopeful note, this year, for the first time since the Paris Agreement, banks have issued more new green bonds and loans than financing for fossil fuels. We hope this shift continues and global banks continue to back a greener future.
We have been allocating to various green, social and sustainability bonds for a while particularly in our Absolute Return and Investment Grade strategies. For example, we participated in the Workspace Green Bond issue, with proceeds allocated towards eligible green projects such as green buildings, energy efficiency and sustainable water management, that are consistent in meeting their ‘BREEAM’ (Building Research Establishment Environmental Assessment Method) excellent target.
A way in which investors can hold companies that issue green bonds to account is via increased interest payments should the company fail to meet their climate change goals. We participated in Enel Finance International’s inaugural sterling sustainable issue, with a coupon step up if they fail to generate more than 60% of generating capacity from renewables by 2022. Our most recent green addition is the Anglian Sustainable Linked Bond with a step-up event if KPIs are not met, which relate to reducing carbon emissions by 2025.
As investors, we are encouraged to see companies come to market with green bond issuance, with many looking to improve their environmental credentials and align themselves to their net zero goals. Green bond frameworks set out eligible projects that the company can put these proceeds towards, with these companies being held accountable through the mandatory annual impact reporting.
There’s enormous potential in this new age of bonds and growth in issuance will likely continue to flourish. Scrutiny is essential though. As investors we must ensure that we’re holding issuers to account through a disciplined approach. That way, we can better assess if the green comes out in the wash.