25 October 2019
Bringing 'brown' sectors to the green bond market is possible, but will require a sophisticated approach to assessing companies' strategies to shift to low-carbon business models, writes Manuel Adamini
The green bond market has grown from zero to $649 billion* outstanding in about a decade. Hundreds of issuers have offered thousands of deals, now coming from about 55 countries.This is a global phenomenon. But it doesn't change the equation yet.
July alone saw the melting of 200 cubic kilometres of ice on Greenland. Pour that melt water onto England, and it stands 1.5 metres deep.We need to urgently finance and deploy measures to mitigate emissions and to adapt to climate impacts already in the system.The speed and scale required, as also stressed by last autumn's IPCC report, are daunting – while we're facing a finance gap of roughly $2.5 trillion per year. Adding wider Sustainable Development Goals to this brings us to $5-7 trillion per year.
We thus need to aggressively scale up. Issuance is so far dominated by top-rated government-related entities, multilateral banks and real estate and financial corporates.New types of issuers are needed fast. With the climate emergency demanding that we spend our money wisely, issuers' funding propositions must relate to strictly and verifiably climate-relevant projects and assets only.Those need to come out of the vital few sectors that make up the bulk of global emissions. While per-sector contributions can vary significantly across countries and regions and are sensitive to sector boundary definitions, the big five tend to be: energy, buildings, transport, energy-intensive manufacturing and materials, and agriculture/land-use (change).
Past green bonds issuance and use of proceeds has been heavily biased toward the first two of those sectors (with the caveat that energy largely refers to renewables investments by power utilities only).Transport has been catching up over the past two years, also thanks to mammoth issuers like Société du Grand Paris, but this largely covers public transport (the recent Climate Bonds Certified Porsche Schuldschein may be a sign of more private transport deals to come?).Manufacturing and materials as well as agriculture have been notably absent - the latter partly because it can be hard to make investible anyway, and in debt capital markets even more so.
It's always bothered me that green bond markets, putting the hype and my own relentless preaching aside, seem to miss a trick here. A massive one!
Markets largely ignore the vital few sectors (except for buildings and energy, to some extent), celebrating the trivial many instead... This must change. The hottest July ever tells us this must change fast.
So, what to do about it?
Repeat issuers lament the scarcity of projects. Investors complain about lack of supply of bonds. We need to activate those segments of the market that have largely been absent but offer huge emissions reductions potential as well as nice yield. It's easy to do some mapping: we're talking cement and concrete, metals and mining, oil and gas (though we can't see a Paris-Agreement aligned pathway here yet – one simply can't ignore scope 3 emissions), petrochemicals, and private transport. This doesn't sound particularly green - and that's exactly the point.
When I first raised the need to bring those sectors to market with some investors (I used to work at one) about four years ago, they dismissed it. Yes, they all supported my thinking. But no, they could never justify to their clients buying green bonds from brownish companies. One had a hard time explaining green bonds in the first place... Green bonds had to come from ESG-beauties (more or less). Anything else was a no-go.
About two-and-a-half years ago, I sensed a slight change in tone: one investor still thought the logic of bringing brown issuers to green markets was good, and one now thought it was conceivable. But nobody knew how to do it, and no one really dared to work on it...
About one-and-a-half years ago, the investor mood dramatically changed. The theme was discussed openly during Climate Bonds Initiative's 2018 annual conference in March, with a good line-up of the biggest (European) investment managers on stage during the opening plenary. I remember those big money managers declaring publicly they'd be open to consider such green bonds and to discuss green strategy shifts with companies on the back of green transactions (with states, too, even – that always used to be called 'political', didn't it?).
That was the moment that I jumped on the phone frantically. I called almost 30 investors in the weeks following our conference, discussing in detail how one could bring brownish companies to market in a credibly climate-relevant way. I am deeply grateful for the insights and pointers provided by many of CBI's investor partners. Their preference was clear: as a top priority, basic materials, heavy industry and private transport should green their ways.
Investors told me they'd love to see a link between what could be a more transactions-driven green bonds approach with the more strategy- and governance-driven Climate Action 100+ engagement. And they wanted to use TCFD as a framework to assess strategy and capex shifts. No wheels should be re-invented, and existing market initiatives should be made mutually reinforcing. But how?
Let's just put them in a room together!
I had what I needed. The investor appetite and in-principle buy-in was there. So I thought I'd try and put a group of investors and metals and mining companies together in a room to talk to one another – and see what happened...
The objective I had in mind was to talk "transition". It was not to talk green bonds or climate bonds right away (surprise?). It was to see companies committed to real strategic change: green intentions turning into tangible and verifiably climate-relevant measures that relate to the core business activities. Such measures would then have to be backed by green capital expenditure, which would bring down non-green traditional capex over time as an indicator of more to come: a reorientation toward a 2⁰C – or rather 1.5⁰C – global warming pathway. All of this should be framed in TCFD language, and companies should be quizzed by some leading Climate Action 100+ investor supporters.
So I phoned loads of bankers, asking them to work with me to bring a decent crop of blue-chip industry representation to the table. ABN AMRO, Barclays and Société Générale agreed to support.
But we realised we'd need some independent guidance. At the time, it would still take a while for the EU TEG's report on taxonomy to come out (it was not even clear that metals and/or mining would be covered at all). Climate Bonds had not yet developed sector criteria, either. So we ran an RfP among high-reputation advisors and think tanks, having been offered some funding by the banks as well as Dutch investor NN IP. In the end, Climate Bonds asked Berlin-based (hey – some home bias here?) academic research institution DIW (Deutsches Institut für Wirtschaftsforschung) to write an independent 'issues paper' on climate challenges and opportunities in aluminium and copper (given their relevance for low-carbon technologies) as well as steel (given the massive volumes). Such a paper would provide a sound basis for a sensible discussion with companies.
So, what happened?
On 3 June, we had some 25 investors gather in Paris. Upon my insistence (up to the point of being annoying, I guess), most brought both ESG as well as credit analysis and/or portfolio management expertise, so that we could cover both angles. Investors wanted to hold this first meeting without companies present, making sure they understood all the issues unearthed by technical expert DIW, discussing amongst themselves, and maybe forming a shared view.
We then had the same group of investors meet with blue chip companies. This was made possible thanks to an incredible outreach job conducted by the three banks (involving their DCM teams as well as their metals & mining desk heads), often engaging their clients at the most senior level for this altogether-new initiative. I am most grateful for ABN AMRO's, Barclays' and Société Générale's willingness to embark on this adventure, supporting Climate Bonds Initiative on a mission-critical project.
The next meeting happened on 28 June in London. By that time, the EU TEG's guidance on two of those three metals was hot-off-the-press. The timing was just perfect. We could now compare DIW's wider view on sector challenges, opportunities and technologies with TEG's very specific benchmarks. We had a robust discussion on the EU draft Taxonomy, and a plenary presentation by one company that had already taken material climate-relevant strategy changes in the recent past. We then broke up in smaller groups for more detailed company-investor presentations with a focus on green assets and projects.
The day was considered a huge success by all. Many investors expressed their admiration and excitement for the mere fact of bringing this group of companies into one room – given that they are pretty fierce competitors... Companies were equally excited to be involved in the market's thought process at such early stage, and to be able to talk to so many investors in one go.
Believe me, an awful lot of energy and time went into this, by all involved. So we're keen to keep the momentum going.
For one, this was a novel concept that's now been tried and tested. Climate Bonds is working on taking the approach to other sectors that are at the intersection of climate impact, investor yield and real economy relevance – and still underrepresented in green bonds markets. Possible candidates could be cement and concrete, petrochemicals (but one simply can't ignore plastics pollution these days); and aviation (notoriously hard to crack, though), cars and trucks, as well as shipping. With some tweaks, the concept can be applied whether or not detailed sector guidance on climate thresholds is already out there (it was not for those metals when we started).
"Climate Bonds is working on taking the approach to other sectors that are at the intersection of climate impact, investor yield and real economy relevance – and still underrepresented in green bonds markets."
Also, we're exploring digging deeper into metals and mining, given the existing engagement with companies. Key questions that came up during the two workshops were: how to deal with (thermal) coal legacy assets? What about carbon intensity versus absolute emissions, esp. when activities are expanding? What are the possibilities of and limits to recycling and reuse? Is maximum renewable energy input good enough, if the chemical processes per se release huge amounts of greenhouse gases (e.g. steel)? Should we judge those inherent emissions differently if metals and minerals vital to other low-carbon technologies are being produced? Or should we rather look at breakthrough technologies and (aggressive) investments in those? And finally: how to balance attention for climate impacts with other (do no significant harm) ESG aspects, e.g. water use and pollution (e.g. tailings), waste, and human rights?
Finally, we want to ensure that companies investigate the EU Taxonomy thresholds where they are already developed, and seek to apply them to their operations. This should include discussions around transition-oriented investments for companies and their projects that do not yet meet relevant thresholds, but where detailed investments plans are in place to get there over time (TEG as of yet limits this approach to the manufacturing sectors). More difficult even would be exploring the concept of 'acting in the spirit of the Taxonomy' for those areas still left blank by threshold setting entirely.
The last word...
All of this is about grappling with the concept of 'transition' – when it's credible, deep enough, and how to judge that. And it's about how to apply it to projects and assets that are to be deployed fast, and at scale.
That is the massive task we've been working on ever since the launch of our own taxonomy back in 2013. We now need to mobilise investors and companies to work with those definitions. That starts with bringing them together around a table. We did that for metals and mining. And we'll keep doing it for more sectors. We'll be back!
"All of this is about grappling with the concept of 'transition' – when it's credible, deep enough, and how to judge that."
Manuel Adamini is head of investor engagement at the Climate Bonds Initiative.
* As of end of September 2019