Will green gilts get the green light from investors?

May 4, 2021

Use of proceeds: clearly defined and ‘additional’

When it comes to working out how the green credentials of these are measured, LGIM believes that the use of proceeds should be clearly defined and relate demonstrably to the government’s overall strategy to achieve its climate objectives.

Morris comments: “in our engagement with other investors, we have also agreed that it is critical to incorporate social considerations into the framework as part of the aspirations to achieve a ‘just’ transition.

Furthermore, whilst the green gilt framework should allow flexibility for different types of spending, to avoid risks of greenwashing, we believe the government should ensure that the use of proceeds relate to projects that bring new environmental or social benefits, and avoid the use of these instruments as simple re-financing tools. In practice, this means that the government will need to identify a large enough stock of projects to allocate proceeds. This has been one limitation of the use-of-proceeds market that has also led to the development of the sustainability linked bond market (which provides greater flexibility with respect to the use of proceeds).”

Weighing up functionality without compromising on ‘impact’

A contentious issue with any green bond is weighing up portfolio functionality against ‘impact’. LGIM does not necessarily see the two as mutually exclusive concepts but the presence of a ‘greenium’, where green bonds have traded at more expensive levels than their non-green counterparts, has posed a conundrum for investors.

“The ‘greenium’ has fluctuated over time and is a function of demand and supply technicals” says Morris. “In Europe, for example, the ECB bond buying programme (which includes green bonds) has had a significant effect on market pricing. Investors also need to consider how other policies and regulations may influence additional demand and supply drivers.

“Currently it is unclear how this dynamic will play out in sterling markets – corporate green bonds are still a very small part of the overall market.

As stated above, we believe that the overall risk exposure remains the same despite the label, and therefore additional justification is necessary to qualify a ‘greenium’. For example, issuance at a new tenor point on the curve may increase functionality by enabling a better liability hedging profile for our defined benefit clients.”

Maturity: Align to strategic objectives

“We have expressed a preference that the maturities of green gilts should be longer dated for two main reasons,” explains Morris:

“Firstly, we believe that issuing at longer-dated maturities could be a benefit to our investors, many of whom are defined benefit pension schemes. It would allow clients to continue to invest in a way that aims to meet their long term liabilities and could increase their investment opportunity set.

In addition, by issuing at such maturities, the proceeds would enable the financing of crucial longer term environmental and social projects with similar time horizons to the debt maturity. This could therefore be beneficial in terms of clarifying to investors how the projects relate to longer-term objectives of the government’s green strategy. It’s worth noting that, from our discussions, we understand the UK is unlikely to follow the German approach of twinned maturity bonds (i.e. issue a green gilt at the same maturity of a ‘non-green’ conventional gilt). It has also been expressed that over time the DMO hopes to build out a green gilt curve, therefore ensuring green gilts are issued at multiple maturities.”

Final thoughts

To conclude, LGIM will continue to be supportive of the government to catalyse a programme of green investment and help develop responsible investment initiatives to help meet the changing demands of its investor base.