UK’s upcoming maiden green gilt
At the 2021 budget, Chancellor Rishi Sunak announced that the UK government would soon issue two inaugural green government bonds, or ‘green gilts’. The first issuance is expected in the summer of 2021 and the second later in the same year. Furthermore, the UK government is planning one of Europe’s largest green bond issuance programmes to help fund the response to the Covid-19 pandemic. There is also a broader aim of positioning the UK as a centre for sustainable finance ahead of the 2021 United Nations Climate Change Conference (COP26), which is scheduled to take place in Glasgow in November 2021.
So far 16 other countries have already issued green sovereign bonds, including Germany, France and Poland. The latter country being the first to issue a sovereign green bond in 2016. Governments have long played an indirect role in redistributing capital towards greener activities by implementing policies that incentivise sustainability. However, the shift to green sovereign bond issuance signals a move towards direct government financing of carbon-friendly activities.
Sustainable bonds – a broader perspective
But how exactly are green sovereign bonds different to other sovereign bonds? A key difference is that proceeds must be used exclusively to finance or refinance eligible green projects. This can include projects related to energy efficiency, or green buildings, renewable energy, clean transport and sustainable agriculture. More broadly, the sustainable bond market has expanded considerably since the inception of pure green bonds 14 years ago. Investors can now purchase from a whole spectrum of sustainable bonds which includes social bonds, sustainability bonds, as well as green bonds. More recently, social bonds have gained significant traction as attention on the S element of ESG has increased. The ongoing Covid-19 pandemic has amplified this trend, with surging issuance related to funding virus support measures, such as vaccine bonds and recovery bonds.
Accelerating growth
According to Moody’s, sustainable bond (green, social and sustainability bonds) issuance totalled a record high $127.3 billion in the third quarter of 2020.1 This was a 30% increase over the previous quarter, which also saw record high issuance. Despite sustainable bond issuance increasing year on year (as shown below), in our view demand still far outweighs supply. This is reflected in most issues being oversubscribed. Accordingly, the global pool of fixed income investors aiming to invest responsibly can no longer be considered a niche market.
It’s not just institutional investors who are keen to allocate capital towards sustainable objectives. The ‘democratisation’ of savings is also giving retail investors more avenues for allocating capital in line with their beliefs. From this perspective, the issuance of UK green gilts is a win-win strategy: supplying a broad investor base with a much sought-after green instrument and enabling the transition to a net-zero economy, as well as boosting the government’s green credentials.
Infographics
Source: *Bloomberg (2021) “Sustainable Debt Issued ($bn) by Instrument Type”, Bloomberg Professional. [Online]. Available at: Bloomberg Subscription Service (Accessed: 9 February 2021)
Labelling considerations
Responsible investors should be wary of taking the labelling of a bond as ‘green/ social / sustainability’ at face value. At ASI, there have been times when we have judged a non-labelled bond to be preferable to a labelled alternative. This is because the sustainability credentials of some labeled bonds can be overstated or worse subject to ‘green-washing’ or ‘social washing’. In some cases, a non-labeled bond issued by a Paris-aligned and credible sovereign could therefore be preferable. A key requirement we think therefore is to look past labelling and to judge the plausibility of sustainability impact claims.
By way of example, in 2018 the Indonesian government issued its first green bond. However, despite its green label, when looking more closely at its planned ‘use of proceeds’, it became apparent to us that this included an element of deforestation. Coupled with Indonesia’s generally mixed history in this regard, and broader compliance concerns, we therefore decided to exclude this bond from our eligible universe.
Assessing green bond financing frameworks
…. the global pool of fixed income investors aiming to invest responsibly can no longer be considered a niche market.
Assessing the financing frameworks of green bond is critical. This is where professional investors can play a key role in ensuring that client money is allocated in line with expectations. While reliance on labelling should be avoided, we do nonetheless see value in a well-established framework for this. Indeed, ASI has played an active role in encouraging the UK Treasury to closely align with internationally accepted ICMA Green Bond Principles. This is because we think reliable labeling can serve as a useful signal that can help to raise the overall quality of sustainable bond markets.
In the case of green bonds, there is also a need to assess the overall green strategic direction of issuers. With respect to the UK’s planned green gilt, we feel the government’s roadmap for achieving ‘Net Zero’ (emissions) by 2050 is credible. Furthermore, its consistent strategy in this regard is supported by numerous indicators of progress.
Summary
In summary, we see the UK government’s planned issuance of its first green gilt as a positive market signal of its commitment to funding green projects. This is part of a broader positive trend of governments increasingly looking to progress from indirect (i.e. policy) to more direct (i.e. funding) support for green initiatives. For responsible-minded investors, this means increasing opportunities. However, amid surging issuance, careful due diligence is needed to ensure labelling matches up to both reality and investor expectations.