15 October 2019
Rather than talk about creating a transition bond label, let's talk about the broader direction of the labelled bond market, says Jacob Michaelsen
We have come a long way in just one year. Back then, the topic of 'additionality' seemed to be on everyone's lips.
Today, 'transition' is in vogue. But, like the 'additionality' discussion, it seems to me that the narrative of the 'transition bond' discussion has been too simple. I maintain that the real discussion to be had is around the broader governance and direction of the market – but more on that below.
Let me first set the scene as to why I believe the 'transition bond' discussion is misleading:
1. We risk getting stuck in the nitty gritty details of 'who can do green' instead of focusing on the much bigger discussion of moving capital in the right direction.
2. It is a topic that lends itself better to subjective opinions in the coffee shops than to the rigorous analysis of the financial markets.
3. It is somewhat hollow to say that an oil company can't issue a green bond if you would buy a green bond from any of the major banks (most of whom have significant oil-related exposure on their balance sheet).
To further highlight the futile nature of the 'transition bond' discussion, the underlying fact is that, as one client pointed out to me recently: "Every company in the world has always been in transition – and always will be. It is inherent in the capitalistic model".
Indeed, according to Cicero's 'shades of green' methodology, everything that is not deemed Dark Green (in layman terms this means full alignment with the maximum 2°C target by 2050) is a 'transition bond'.
Finally, to further clarify my point, I want to reference the comment by Hervé Duteil in his recent two-part opinion piece: "Let's be clear: Transition Finance is not about transitioning from 'brown' to 'green': that is Green Finance. Transition Finance is about transitioning from brown to... brown; a lighter shade of brown, of course," he said.
Although I appreciate the reasoning of such an argument, I would disagree. As I see it, there is only finance – either sustainable or not. Indeed, 'sustainability' itself will always be a transitory concept. Furthermore, by separating 'transition finance' from 'green finance' we inadvertently increase the risk of 'greenwashing'.
A new modus operandi for the labelled bond market?
Instead of arguing about 'transition bonds', we need to look at the discussion from a broader perspective. In my view, the 'transition bond' discussion is just the tip of the iceberg of a much bigger and more pertinent discussion concerning the direction of the labelled bond market (and sustainable finance more broadly).
What we should be focused on is not whether, say, a shipping company should be able to do a green bond, or a cattle rancher issue a sustainability bond, but rather if we believe that the current governance and structure of the labelled bond market is adequate to address the flurry of labels we have seen recently, such as 'SDG bonds', 'blue bonds', or 'gender diversity bonds'.
Let me be clear: I believe the Green and Social Bond Principles, with their simple and flexible structure, have been the perfect model for the labelled bond market to go from niche to global – an impressive achievement indeed. However, we should not be blind to the fact that the underlying modus operandi of the labelled bond market has evolved from a static market, characterised by a homogenous asset pool (mostly renewable energy) and supply base (mostly Sovereigns, Supranationals and Agencies (SSAs)), to a vibrant and dynamic market, characterised by a variety of green assets and a much faster pace.
The 'transition bond' discussion is just the tip of the iceberg of a much bigger and more pertinent discussion concerning the direction of the labelled bond market (and sustainable finance more broadly).
In such a market, this simple and flexible governance structure might still work, but maybe it will not be the most efficient or best-suited to address the challenges we face.
When I look closer at the market and the 'transition bond' discussion, it is evident to me that there is real appetite and interest in being able to talk green even, in fact especially, in controversial sectors.
To me, this is an opportunity for us, as a market, to help support the transition and make profits along the way. Obviously, we need to maintain a high degree of integrity and sensibility when going about the difficult task of defining positive impact. But it seems clear to me that we could all benefit from a market structure and governance model that would be supportive of a more nuanced discussion of green/sustainability.
Still, it is important to remember that feasibility and a market-orientated approach needs to be at the core of the labelled bond market going forward. When speaking to both issuers and investors, I clearly get the sense that the ones who tend to be most up-in-arms when a controversial or transition bond discussion is brought up are either fund managers with dedicated green labelled funds or issuers from sectors where the green discussion is more straightforward – and maybe the occasional NGO or sensationalist journalist looking for controversial topics.
Labelled versus non-labelled and ESG integration
Indeed, transitioning in the global economy also requires us to transition within the financial market – that is, the transition from 'use-of-proceeds' style labelling to a broader realisation that sustainability needs to be integrated across the entire financial market value chain. This is, in essence, what the European Commission's Action Plan for Sustainable Finance is all about.
"It is my opinion that the main goal of the labelled bond market should not be simply to increase the volume but rather to serve as a stepping stone for us to transform the entire financial market."
At the end of the day, it is my opinion that the main goal of the labelled bond market should not be simply to increase the volume but rather to serve as a stepping stone for us to transform the entire financial market. Labelled bonds have shown us the value of transparency – that should become the norm, regardless of a label. Further, we need ESG integration to be a fundamental building block of financial analysis – alas we are still some time away from that.
Yes, we need a focus that at the end of the day shifts capital away from 'brown' investments – however, that shift should not be binary but rather a progressive push that helps everyone on the way, regardless of the label.
If we, as a market, truly want to support the global transition to a low-carbon economy, we need to move forward from the situation where the only thing it seems that we can focus on is the controversy of 'who can do green' – I am sorry, but this is peanuts.
Wrapping it all up – three key highlights and a thought on how to address them
To sum things up, let me clarify my plea to the market:
- Transition' is clearly a relevant topic. However, I am unsure whether a separate label for such bonds is the appropriate way forward for us as a market. It seems to me that there are potentially more downsides than upsides of doing so.
- Instead of discussing 'transition bonds' we should focus our attention on addressing the current approach to, and governance of, the labelled bond market. In the long run we might very well need to disregard labelling altogether and only refer to 'use of proceeds'-style bonds where the targeted impact is always disclosed – regardless of the proceeds.
- Finally, we need to pay closer attention to the link between use-of-proceeds and overall ESG integration – and how both aspects are important tools to help us in moving capital aligned with a low-carbon economy. Fleshing out what 'strategic alignment' means might be a good place to start.
To address these points it is evident to me that we need to make some big and bold steps in the months and years to come.
What exactly that will look like I won't claim to know today. However, considering the impressive momentum we have seen in recent months, it wouldn't surprise me if the answer is to be found, at least partly, in the European Commission's Action Plan on Sustainable Finance.
Regulation will also likely be an important component of this, but it won't be enough – the regulators might set overall rules of the game, but it will be up to us, as a market, to figure out how to raise our game to the next level.
Jacob Michaelsen is head of sustainable bonds at Nordea. His previous piece can be read here