Bonds pack a bigger green punch than equities

UK’s sterling green gilt debut is helping to force change

The huge demand for a £10bn inaugural green gilt issue from the UK underscores that bonds are better positioned to accelerate change in sustainable finance than equities, according to Lori Heinel, global chief investment officer at State Street Global Advisors.

She was speaking at OMFIF’s ‘Building sterling as a world-beating green bond market’ seminar on 11 October. ‘Clearly green bonds will play a pivotal role in the transition to a more carbon free future. The bond market is more immediate in many cases than the equity market – there is just a lot more issuance, it is more frequent and you have the ability to drive proceeds to invest in the future we are all trying to achieve,’ Heinel said.

John Glen, economic secretary to the UK Treasury, was keen to stress the success of the country’s first green bond, which came after criticism that Britain had been slow to issue debt tied to sustainable economic goals.

‘This is the largest ever sovereign green bond issuance, the largest ever order book for a sovereign green bond and the largest ever “greenium” for an inaugural offering,’ Glen said. ‘It is also a valuable signal to corporate issuers – there are serious financial and strategic wins waiting for you if you choose to go green,’ adding that one goal for the government was to ‘leverage private capital to multiply the effect of public investment.’

The ‘greenium’ for the UK’s bond refers to the premium created by strong current demand for debt that is linked to environmental, social and governance goals. Market participants are divided over whether this greenium will persist and whether it is necessary in order to prompt more borrowers to join green finance markets.

‘We might see the greenium decline,’ said Eoin Murray, head of investment office at Federated Hermes. Murray joined State Street’s Lori Heinel in hailing the capacity of bond markets to have a meaningful impact on a shift towards sustainable finance. ‘There are effectively two ways we can change the nature of the economy – one is reallocation of capital and the other is engagement of existing capital to change expenditure,’ Murray said.

‘In secondary markets – particularly equities – the only option you have is engagement. There is no real capital reallocation at all. But in the primary markets – particularly the fixed income markets – that is where real reallocation happens,’ he added.

Murray asked representatives of the UK government attending the seminar whether a move towards linking all debt issuance to sustainable finance goals was feasible. Jessica Pulay, co-head of policy and markets at the UK’s debt management office, described this as ‘an objective to try to reach over time perhaps.’ She stressed that an immediate goal is to ensure that the liquidity of green bonds is comparable to that of conventional gilts.

‘A concern could be that if you try to bring too many new products you could risk fragmenting the market,’ Pulay added. She said that the UK’s inaugural gilt, with its 2033 maturity date along with a second deal with a 2053 maturity, was designed to develop to become the 10-year and 30-year benchmarks that investors seek in government debt. The new green gilts will also be eligible for inclusion in benchmark bond indices, for use in repurchase financing and for Bank of England money market operations.

Mario Pisani, deputy director for debt and reserves management at the UK Treasury, highlighted the inclusion of social goals in the government’s first green gilt, along with the coming addition of green savings bonds targeted at retail investors to the green gilt programme, which has been set at a minimum of £15bn for the current financial year. Pisani also echoed John Glen’s point that the inaugural green gilt issue has established a new reference for corporate borrowers.

Jean-Marc Mercier, vice-chairman for capital markets in the global banking and markets group at HSBC, pointed to the progress that has already been made in green corporate bond borrowing in the UK, where 45% of issuance in the year to October has been linked to sustainable goals, compared to 11% in all of 2020.

The market for sterling issuance of green bonds is not limited to UK borrowers, as Heike Reichelt, head of investor relations and new products for the World Bank, pointed out. She said that a recently announced plan for $10bn of sustainable development bonds by the World Bank will help to encourage issuance in currencies including sterling by borrowers of different types.

Reichelt added that the World Bank – which issued its first green bond 15 years ago – is working with emerging market sovereign borrowers to ensure that they can access sustainable debt markets. Colombia issued its own inaugural green bond at around the same time as the UK’s debut, for example, though without attracting as much global attention as the £10bn gilt.

While investors are showing enormous appetite for ESG debt, they face some issues in comparing different assets because of ongoing differences in the taxonomies adopted by borrowers to define green and sustainable goals.

‘Increasingly people are looking at the outcome measurement – the key performance indicators – and, to the degree that the underlying frameworks are dissimilar, it is much more difficult to measure the impact,’ said State Street’s Heinel.

Murray at Federated Hermes said that end investors always welcome as much granular information as possible, but warned that the market for ESG assets needs to continue to work on developing standards. ‘If markets don’t get themselves organised then you get regulation imposed on you,’ Murray said.

Jon Macaskill is a financial writer covering global markets and a columnist for Euromoney.

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