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Will green gilts get the green light from investors?

Are accusations of greenwashing well founded? Are they worth the “greenium”? As the UK Government looks to capitalise on the growing interest in sustainable investing, Legal & General Investment Management (LGIM) examine the differences between green gilts and the more traditional gilt-edged securities that we’re so familiar with.

What are green gilts?

At his ‘Future of the UK Financial Services Sector’ speech in Parliament on 9 November 2020, the Chancellor of the Exchequer announced that “to meet growing investor demand, the UK will, subject to market conditions, issue our first ever Sovereign Green Bond next year [2021]. This will be the first in a series of new issuances, as we look to build out a “green curve” over the coming years, to help fund projects to tackle climate change, finance much needed infrastructure investment, and create jobs across the country”.

It was subsequently announced in the Budget 2021 that the government will issue its first sovereign green bond – or green gilt – this summer, with a further issuance to follow later in 2021 as the UK looks to build out a “green curve”. According to the UK Debt Management Office (DMO), planned green gilt issuance for the financial year will total a minimum of £15 billion. The green gilt framework, to be published in June, will detail the types of expenditures that will be financed to help meet the government’s green objectives.

LGIM have been long-term advocates for integrating ESG (environment, social and governance) factors into their investment process. They are also recognised by advisers as being strong supporters of fostering innovation towards green growth and helping clients navigate this new market.

A balanced approach

When it comes to ‘green gilts’, LGIM believes that a balanced approach is necessary in order to understand how they could fit functionally into portfolios and where, as investors, additional comfort is needed about the ‘impact’ and ‘additionality’ of the bonds.

In 2020, the group published a short piece on green gilts, addressing some of the key considerations. A lot has changed since then, including the Chancellor putting theory into practice by announcing the issuance of the first ever sovereign green bond to inaugurate a domestic green gilt market.

On 27 January 2021 the UK DMO, on behalf of HM Treasury, announced that HSBC and J.P Morgan have been appointed as structuring advisers for the first issue of a green gilt. LGIM continues to engage proactively with the UK DMO, the Treasury, HSBC and J.P. Morgan and with industry working-parties to express its views on how these gilts should be put to market, taking into account the considerations outlined above.

There are particular key areas of focused engagement with stakeholders, through which LGIM aims to align the issuance of green gilts with the needs of clients. These are as follows:

  1. Green bonds – an ESG perspective

As Anne-Marie Morris, Senior Solutions Strategy Manager, at LGIM explains “critically, we emphasise that the overall ESG risk exposure of the bond is the same when compared to the non-green counterpart – this is because the repayments of interest and principal are funded from the same balance sheet/cashflows of the issuer.

“This therefore is relevant when considering the portfolio application with respect to pricing, liquidity and other instrument features. It is vital to analyse how the bond can improve the risk and return characteristics of the investor’s portfolio. It is equally important to understand whether these bonds generate ‘ESG impact’ for investors. One criticism in the market of these bonds has been the degree to which they generate ‘additional’ impact above and beyond the use-of-proceeds for a ‘conventional bond. Accusations of greenwashing persist, and across sovereign and corporate issuers we have seen the full spectrum of quality and sophistication of sustainable bond frameworks. For example, some bonds have long ‘lookback’ periods, meaning green bond proceeds can be used to re-finance projects that have already been undertaken.”

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