Green bond comment, December 2020: Should the UK issue a green gilt? Not necessarily

Channels: Green Bonds, Policy

A green bond can help to shine a spotlight on a credible transition strategy. But it cannot substitute for one, argues Peter Cripps

Over coming months, the UK will find that its plans to tackle climate change will come under growing scrutiny because it is hosting the next climate change summit, COP26, in Glasgow in November.

This COP is a biggie because it is now five years since the landmark Paris climate change agreement, and the process of asking countries to ratchet up their commitments needs to gain momentum.

The fact that the COP has been delayed by a year because of Covid only heightens the importance of the event.

With the UK under pressure to demonstrate leadership, it is no coincidence that it recently said it will issue a sovereign green bond, some time next year, depending on market conditions. Chancellor of the Exchequer Rishi Sunak said the green gilt will be the first of a series of green sovereign bond issues by the UK government over the next few years as it looks to build a green bond yield curve.

19 countries have already issued sovereign labelled bonds, according to Environmental Finance's Bond Database, raising some $92 billion. It is fair to say that the UK has been slow off the mark when it comes to issuing a green bond, particularly as it is a significant issuer of sovereign debt.

So, as someone who is passionate about sustainable finance, I ought to be thrilled by the announcement. And yet I feel underwhelmed.

Let me explain. What I really want is for the UK – the country in which I happen to have been born – to be in the vanguard of countries taking action to tackle climate change.

I believe it has an obligation to do so. Greta Thunberg was right when she said that the UK has a "mind-blowing historical carbon debt". It was the first country to industrialise, and thereby effectively initiated manmade warming. The UK therefore has a duty to help solve climate change, just as the country was one of the leading participants in the slave trade, but then saw the light and helped to bring an end to the evil practice.

And I want the UK to go further: as well as sorting out its own emissions, I want it to help other countries to do the same, using its considerable expertise in renewable energy and finance, for example. If I had my way, this would be the UK's role in the world, its mission.

Becoming the world's first truly sustainable large economy would be no easy task, I accept. It would require a comprehensive and well-thought-out strategy covering the entire economy, including not just energy generation, but also the UK's energy-inefficient building stock, its industrial sector, its agriculture, its transport, and its financial sector. As a country reliant on imports, it also needs to think about the carbon footprint of these, perhaps with a carbon border tax.

It requires vision, and a roadmap for how to reach the promised land, described by Thunberg as "cathedral thinking".

The UK's recent track record is not bad – it has taken a leading role in the offshore wind industry, for example, and coal barely features in its energy generation any longer. Its electricity grid is moving fast in the right direction.

But I simply do not see a well-thought-out and coherent strategy from the UK. There have been some breezy words from its eccentric Prime Minister, Boris Johnson, making claims that the UK will be "the Saudi Arabia of wind", for example. His recent 10-point plan also involves banning the sale of new internal combustion engines for cars and vans by 2030, and there is a target to be net zero by 2050.

There are some exciting promises being made, but little substantial information about how to meet them.

There is less than a year to go until the big jamboree in Glasgow, and preparations for the event so far have been chaotic. The president of the event, Claire Perry O'Neill, was sacked at the start of the year, and hit back by revealing that Johnson said he doesn't understand climate change.

Meanwhile, with less than a month to go until the UK fully leaves the EU, it has still yet to decide whether it wants a carbon tax or an emissions trading scheme.

A key energy strategy paper has been repeatedly delayed.

And the UK's relatively generous foreign aid budget, which can be used to help other countries decarbonise their economies, is to be cut.

It will be interesting see whether Johnson has anything more meaningful to offer when he hosts a virtual call with other leaders on 12 December – the fifth anniversary of the Paris Agreement – to discuss climate action.

But, for the meantime, plans to issue a green gilt worry, rather than enthuse, me – there is a real danger that the UK government sees such an instrument as a publicity stunt to get critics off its back, and will use it as a token gesture to show action ahead of the COP26 summit. There is a reputational risk for the green bond market.

A green bond can help to shine a spotlight on a credible transition strategy. But it cannot substitute for one. But if a strategy is put in place, it can then be used to showcase all the green projects that the government is funding.

The incentives to issue a green gilt are not clear. For example, there is not really a perceivable reduction in funding costs, particularly with interest rates so low.

Nor can the UK claim a first-mover advantage by issuing a green bond – it lost that opportunity years ago, having been beaten to it by the likes of France and even coal-addicted Poland.

However, there are some potential upsides. A paper from the London School of Economics in collaboration with the UK's Green Finance Institute (GFI) and Impact Investing Institute, and supported by 30 investors, asset owners and organisations, calls on the UK to issue a 'green+' gilt, whereby it will also focus on social issues such as the creation of green jobs. This could put a welcome focus on the 'just transition' ahead of COP26.

A green gilt issuance also could help to stimulate domestic issuance of green bonds.

What a green gilt issuance would really achieve is to put the UK's green credentials into sharp focus. The media in the UK are notoriously savage, and as soon as the UK issues a green-labelled bond it will be picked to pieces by the press.

So far, there have been numerous uninspiring sovereign green bonds, whose use of proceeds can often support activities such as dredging of rivers and reclamation of soil heaps. Some issuers have not really made a serious commitment to the green agenda.

These issuers may have escaped criticism, but the UK is in a different political position, a different point in time, and its COP presidency means that it has more responsibility.

So, what I really want from the UK government is a strategy to transform itself into a beacon green economy that others can follow. Sadly, a green bond does not necessarily perform that task.

And that is a shortcoming of the green bond market itself, I'm afraid – that it is possible to issue a green bond and designate use of proceeds to green activities without the issuing entity being green in its nature or having a plan to become green.

As has been previously written in these comment pages, the green bond market has achieved a great deal in its brief history, including by helping to initiate conversations about sustainability issues and build capacity for understanding and quantifying these issues within investor and buyer organisations.

But the fundamental limitation of green bonds, that they do not necessarily require a robust green or transition strategy from an issuer, is being increasingly criticised.

This fact was a major talking point at a conference on ESG and Fixed Income last month. I see this as a healthy development because green bonds will need to evolve to cater much more robustly for the sustainability credentials of the issuer itself, rather than just the use of proceeds, or will become obsolete.

The green 'use of proceeds' model could also be superseded by the sustainability-linked bond format, which if structured correctly, can link an issuer's cost of capital with an impactful sustainability target.

In conclusion, for the UK's green gilt to have real credibility, it needs to devise a credible strategy to transition the economy and a plan about how to finance it.

In the long term, I believe that will help the risk profile of the UK's bond issuance – not just the ones on which it slaps a green label. If it cannot devise such a plan, it should leave the green label in the cupboard.

Peter Cripps is the editor of Environmental Finance.