IFR Green Bonds Roundtable 2017: Part 1

Nick Herbert: Welcome to the IFR Green Bonds Roundtable 2017, sponsored by the European Investment Bank (EIB), Luxembourg Stock Exchange and Moody’s Investors Service.

In May, we saw an important deal for the market: the first Green bond from a major oil and gas company. The Repsol €500m five-year issue provoked a lot of comment. Proceeds went towards financing energy efficiency investments in its chemical and refinery facilities, yet it failed to make it into the Climate Bond Initiative’s (CBI) family of listed Green bonds and missed out on inclusion in the major Green bond indices.

What does the debate around the deal say about the current state of development in the Green bond market?

Nicholas Pfaff: The market currently operates largely on voluntary principles. When an issuer wants to come to market, it should look to the Green Bond Principles (GBP) for guidance, speak with its chosen underwriter and an external reviewer, and based on those discussions, take a decision on issuing. If it goes ahead, it’s then up to the market to decide on what it thinks of the Green bond based on its alignment with the GBP and the information provided as a result.

The focus of the Green Bond Principles is indeed to ensure that transparency is maximised. With Repsol, for instance, the questions raised were not on the borrower’s good intentions or on the quality of the information provided. It was rather whether Repsol’s project was sufficient from the point of view of, for example, the reduction of CO2 emissions; and whether the company had clearly signaled where it was at and where it was going with its transition story.

The Repsol deal underlined the challenges faced by a company from the fossil fuel industry to issue Green bonds, and highlighted the importance of having a comprehensive transition story, the value of transparency and the key role played in the market by third parties, such as external review providers, the CBI and indices.

Harald Lund: For us at CICERO, defining green is not a black or white issue; it’s for the investor to make the final decision on that question. We’re here to provide transparency. We take what we know from climate science and inform the market from that perspective.

Two years ago we introduced a methodology that we call “Shades of Green”, which expresses how well a Green bond aligns with a low-carbon climate-resilient future. It ranges from dark to medium to light green.

The dark green solutions conform to the 2050 target of meeting global energy demand entirely without emissions such as with renewable sources, while the light green solutions are those we need in the shorter term.

In that respect, we would allow for Green bonds to be issued by the fossil fuel sector, but they’ll most likely get a light green shading. It’s great that emissions are reduced but we are particularly concerned about proceeds that go towards prolonging the lifetime of facilities that emit greenhouse gases rather than phase them out.

We think it’s important that companies from the fossil fuel sector should join this market, but we need to set the bar high for the use of proceeds so that we don’t prolong the lifetime of those projects.

Robert Scharfe: When you’re looking at the Repsol case, I think the whole debate in the market shows simply that there is not a single type of investor out there. There are many different investors, each with different policies and criteria. One likes a bond, the other likes it less, and others don’t like what they see at all. Basically, the case of Repsol is a question of a shade of green, at the end of the day. How green is that bond? And the appreciation is likely not uniform.

Transparency is the key element in here. That means investors need to get access to the information that allows him or her to make an informed decision. That’s what’s important. That’s where the complexity of the bond market comes into the picture.

On one hand, in order to list a security on the exchange we need to comply with a number of regulatory requirements according to prospectus directives and other rules that apply on different exchanges. Here, when we talk about green, it’s about voluntary elements.

Now, how does the investor get access to these voluntary elements; the second opinions; the impact reports and everything that turns around that; the environmental, social and governance (ESG) policies and what have you? When you are looking at the market today, every Green bond issuer would probably claim that you get this type of information on the respective website. What is more important for investors is that they are getting access to one platform where all of this is available and where you can compare the information between the different issues.

That’s what we do. We are putting all these voluntary elements at the disposal of the investor. By the way, retail or institutional investors, it does not make any difference. Everybody has access to that platform and to that information. On top of that, it’s free. It’s up to the investor to decide ultimately on what they like or don’t like.

The debate around Repsol is interesting but in my opinion it’s the wrong debate. We are talking about climate transition. This is a long-term process, and every action that’s taken by issuers to go the right way should be valued and encouraged by the market.

At the Luxembourg Green Exchange we want to avoid, above all, splitting the world into the good guys and bad guys. We don’t want to hear “You are coming from the wrong industry, too bad for you”.

We should encourage all the Repsols and Exxons of this world to go that route, subject to certain guidelines of course, following certain criteria. But, in fact, it’s a move in the right direction and that should be encouraged.

Irene Sanchez: This case is related to the absence of an international definition of what is green. In the end, investors need to look at whether the energy savings that are achieved with that particular project are substantial or not; in other words, what is the main motivation of the investment? That would be one lesson learnt from this case, whether the main driver for the project is achieving significant energy savings or simply the replacement of the assets. By nature, if you replace an older asset with a newer one it will save certain emissions because it’s simply more efficient, but is that really enough?

I think there needs to be certain thresholds. At the EIB we do have those thresholds. However, because there is no definition of green, then the assessment on what’s substantial and what’s not is currently being made by the different market participants. More attention needs to be paid to what is the threshold of being a substantial saving and what is just normal, business as usual.

Nick Herbert: Investors have the power to decide on what’s green; they can make their own choices. But in this case the bond didn’t make it into some of the major indices. There is another level of investment decision there. Chris, what do you think are the implications of bonds from the oil and gas industry missing out on inclusion on the indices?

Chris Wigley: We’re not benchmark driven at all. Security selection is at the heart of the process. We will have issues in the portfolio that are not in the indices and there’ll be issues in the indices that are not in our portfolios. We do use the Bloomberg Barclays Green Bond Index as a reference index and I’d say something like 10% of that is not eligible for investment.

All investors are different; they have different values. There are a number of examples that illustrate the differing views on projects. For example, clean coal is acceptable in China, but tends not to be acceptable in the west and large-scale hydro is fine in the Nordic regions and Europe, but it’s more controversial in developing countries where it might have an environmental impact or may have implications for indigenous people.

I think Nicholas really hit on the important issue earlier when he talked about transition.

It’s interesting to compare the Repsol issue with one from a couple of years ago when a Thai oil company issued a Green bond. There, they said that the money was going to be used to reduce revenues from the fossil fuel industry and increase them from the renewable energy sector. It was part of this transition story.

Although we don’t have any investments in oil companies in equities or in bonds we may make an exception for a Green bond if it’s part of a transition story.

Companies transitioning to a more sustainable environment are important to us. We are asset managers. We’re there to deliver a financial performance and those companies that don’t adapt to new environments and change with the times do become a financial risk or a default risk.

I think transition as well as transparency and impact will be key going forward.

I’m fortunate enough to have a large team of ESG analysts to support me, more than 12 analysts. When there’s a new issue the analysts will attend the roadshow with me and I will get a report very soon. I get a view within two hours and a report within two days, so we’re ready for the launch.

It’s very important to have a roadshow so investors know what the projects are. They can ask questions. This really informs the debate and debate is essential in this market.

Our analysts are very happy to give feedback. Sometimes we have issuers come to see us months before issuing to ask for guidance or some idea as to what investors are looking for.

The feedback our analysts gave to Apple after their first issue was: “Look, it’s very good to see you funding renewable energy, and water sustainability but you’ve got direct control over your product portfolio. Why don’t you do a little bit more there?”

I’m pleased to say that Apple’s second Green bond focuses on their product portfolio in terms of funding research into sustainable materials and assisting in the recycling of old phones.

It’s all part of a transition story and it’s a part of “greening” a product portfolio, but not all issues are like that. For us as an investor, not all issues are eligible for investment.

Nick Herbert: Rahul, Moody’s rated the bond Baa2. What did it have to say, if anything, about its “greenness”?

Rahul Ghosh: When we rate a bond, Green or otherwise, underlying that is the appropriate rating methodology for that particular industry, which we use to make a judgment on an issuer’s creditworthiness and, ultimately, its credit rating.

Our Green Bond Assessment (GBA) is not about the overall creditworthiness of an issuer. It is a forward-looking opinion about how the use of proceeds for a Green bond is being articulated, what kind of disclosure and ongoing reporting there is, and what kind of management, administration and governance practices are in place.

One of the key characteristics of our GBA is that it’s about the asset rather than the issuer.

In the case of Repsol and, in fact, more broadly, there are two primary dynamics that underpin the whole story; green transition and green integrity.

If we do want to transition to a low-carbon economy we can’t just rely on pure-play green companies. In fact if we did there’s no point really to a Green bond market. We need to encourage so-called brown balance sheets to transition. Companies in the oil and gas industry, for instance, are major owners and investors in renewable energy. To get carbon-intensive companies on board is critical if we’re going to move towards the very ambitious targets that we’ve set.

Having said that, integrity is important. A number of us were in Paris to see the launch of the Green Bond Principle 2017 update. There were some pretty interesting developments, but I’ll just speak about one. Principle two was updated so that issuers should articulate not just what their Green bond story is, but how it fits into their broader sustainability agenda. In other words, to explain what they are doing in terms of overall sustainability and how does the Green bond fit in the context of that strategy.

I think that’s an interesting development in the Green Bond Principles that hopefully will help to alleviate some of the concerns about integrity.

Nicholas Pfaff: I think the change we made to section two of the 2017 GBP – ie. emphasising that an issuer needs to communicate its overall environmental sustainability strategy - is indeed very pertinent to this case. I’d like to add that we were thinking about it before the Repsol Green bond.

We looked more generally at how the Green Bond Principles fit into the overall ESG space or in relation to the UN’s Sustainable Development Goals (SDGs). We discussed whether we should position ourselves more clearly within that framework.

The outcome was that the GBP should remain distinct in the sustainability debate. At the same time, however, we want to make it very clear that the GBP are pointing in the same direction, and Green bonds generally finance projects that are consistent with the SDGs, for example.

Sandrine Enguehard: I think that for the Green bond market, we are getting to a time when we need to find solutions to finance energy transition. Repsol is an illustrative case of how the Green bond market would accompany oil and gas actors engaging into this transition, addressing the way they finance it, and the way they are developing it. Clearly, we are missing some guidelines regarding impact reporting, which is a key element when we are focusing on transition to address investors’ expectations when assessing issuers’ transition targets

We are not talking about renewables here, which is a relatively straightforward subject to assess; it’s a more difficult process for transition where we need to evaluate the impact of the project.

The Repsol deal, I hope, can be seen as contributing to the development of the Green bond market. It’s part of the progress to the market’s maturity. No doubt there will be other issues in the future that highlight the type of challenges that need to be overcome.

What is certain is that the market is dedicated to determining what goes into impact reporting. I think that assessing the impact of the underlying project being financed is a significant element in evaluating a Green bond.

Nick Herbert: Inclusion, exclusion, additionality. The Repsol deal is not the first to be excluded from the CBI’s list and some climate-aligned bonds have decided against going green in any case. I can’t think of any examples of a bond not selling because it was not pronounced as Green, and there is little significant economic reward for issuing Green bonds, it seems, in terms of new issue pricing and spread. In fact, there are costs associated with going green. So, what are the benefits to borrowers of issuing Green bonds?

Irene Sanchez: Speaking from the point of view of the EIB as a seasoned issuer in the Green bond market, there are clear benefits. One is obviously the diversification of the investor base that we achieve. There are dedicated green portfolios that are willing to play in green deals. It doesn’t mean that other investors do not participate, but there is clearly a significant pool of dedicated green investors whose presence definitely helps in providing momentum to the bookbuilding process.

And even if there is generally not yet any notable difference in pricing between Green and non-Green issues, we have started to see some outperformance in the secondary market for EIB’s Green bonds.

It’s important to say that Green bonds and non-Green bonds are the same product credit-wise, benefitting from the same guarantees and the same ranking, hence, equally priced in primary. The market then decides the evolution of pricing in secondary. And it’s true, we’ve been observing in the last months some slight tightening in pricing of our Green bonds versus non-Green bonds. We think this is due, on one side, to the fact that we are providing a liquid benchmark curve. We are committed to providing green lines covering a different spectrum of tenors and in similar sizes, so the market is recognising that there is sufficient liquidity to enable proper trading of Green bonds. Additionally, I also think that the market is recognising the efforts made by the EIB in bringing transparency to this market. We have been constantly committed to, and delivered on, new levels of transparency in reporting. We’re not stopping. We want to promote the best market practices and we are leading with the example. Investors know that by buying a Green EIB Bond they are investing in a green security with the highest standards of transparency.

I would also say that the cost of issuing a Green bond is mostly a one-off cost. There are internal processes that need to be put in place, particularly at the treasury level, to monitor the proper allocation of funds that are directed only to green projects, for instance. But I contend that it also brings benefits to an organisation as it ensures that processes are more aligned and collaboration between different teams, which is also beneficial for the rest of the bonds. In the end, it’s the whole capital structure that gains from having better processes.

Nick Herbert: I think we’ll move onto the next challenge to overcome, which is Donald Trump. The Paris agreement affirmed the political will to address climate change and to create the environment that finances it. That strength of will is currently being tested. Irene, what are the implications of the US withdrawal from the Paris agreement?

Irene Sanchez: Well, I think scepticism is really at the White House level. When one looks at the market, at US municipalities and US corporates, they are very supportive of the development of green finance. International companies, for instance, feel the pressure anyway, from the markets in which they operate, from regulators, from customers, etc.

In practical terms, honestly, I don’t think that the US withdrawal is really going to affect the commitment to address climate change that is already established around the world. It is, in fact, more likely to encourage a stronger relationship between Europe and Asia, leaving this now-stronger coalition to write the rules of how to move to a cleaner economy.

I am not worried about the lack of global support for the development of a greener economy. It may be that Donald Trump makes life easier for fossil fuel companies, but he is definitely not going to stop progress towards a cleaner economy.

Rahul Ghosh: It is disappointing that the US has decided to withdraw from the Paris agreement.

I don’t think there’s anything too much to worry about today, though, as we’ve seen a groundswell of grassroots support from the US and elsewhere for the Paris agreement. But what will be a challenge is that part of the Paris agreement is about ratcheting up targets over five-year periods to move towards a less than two-degree warming scenario. Greater ambition will require strong, collective policy support.

There is a silver lining, however, and that comes from the real institutional and private sector momentum behind addressing climate change that we’re seeing. In June, the Financial Stability Board (FSB) published its final recommendations for climate-related financial disclosures. This will help to set some direction, as will other initiatives such as the European Commission’s High-Level Expert Group on sustainable finance, and the G20 Green Finance Study Group.

It’s the same in the private sector, where the likes of the UN Principles for Responsible Investment (PRI) has signatories with some US$68trn of assets under management signed up to better incorporate ESG issues into investment practice.

Nick Herbert: Harald, what does it say about our chances of reaching our targets for climate change?

Harald Lund: I think that even before Donald Trump was elected president it was going to be hugely difficult to achieve the two-degree goal, and it hasn’t become any easier after his election. The transition to a low-carbon, climate-resilient economy is an immense challenge and we need all governments to step up their efforts.

The Green bond market has, in effect, been created to fill the policy gap left by governments. We see a trend now that investors and issuers are themselves driving the Green bond market. It’s an example of how actors are, independently, bypassing the policymakers.

That’s not to say that we’re not seeing good initiatives on the government side, at the regional level or in cities etc. And with Europe and China showing great commitment, along with the US at the state level, then we might have a chance of hitting the targets. But if we were going to achieve the two-degree goal and even the 1.5-degree goal, then we would need all regulatory support also from the US at the central level. It’s an immense challenge ahead of us.

Nick Herbert: Yes, it seems to me that this is an opportunity for the other signatories to step up their resolve. What should they be doing, Robert, in your opinion, to address the subject of climate change?

Robert Scharfe: I would like to share just two numbers. Only a week or so ago, at the Environmental Finance Green Bond conference, the response of an audience poll asking a question on the impact of Trump, just 16% thought it had negative implications. Some 42% of the audience thought it would have the opposite effect; that Trump’s decision would actually galvanise corporate America to move forward more quickly. I think corporate America stands very clearly behind the objectives of the COP21 agreement. That’s a good sign, but without the US government on board, the process will unquestionably be slowed down.

Having the US with us would definitely be much better although there is a valid argument that his decision may, in retrospect, turn out to be good for the climate, since it is offering the stage to China. They’re already the most important actor in climate finance and this might actually accelerate the internationalisation of China, thereby creating a broader universe of bond markets; one that the US will ultimately have to participate in, whether they like it or not.

Now, overall, what we need in order to accelerate the development to greener economies is more sovereign action. We need many more Green bonds from sovereigns. France has led the way with an OAT and Poland has done a smaller bond, but where are the other European nations? Where is Germany, which is a dominant force in energy transition?

If they were to issue not €6bn or €7bn, but €50bn of Green bonds, then that would make a difference and that would serve to encourage other nations to follow. It’s nice to say we need the private sector to get more active, but we need governments to enter the game more decisively. The private sector will follow from there, but we need some guidance from the top.