09 January 2018
A green bond market pioneer, Spain’s BBVA has made green finance central to its strategic direction. Three of its sustainable finance specialists discuss the present and future of the market with Environmental Finance
Environmental Finance (EF): Over recent years, you've brought several companies and other issuers to the green bond market. What has motivated these organisations to issue green bonds?
Angel Tejada, Director, Fixed Income Origination and Sustainable Finance (AT): There many reasons, but the fundamental one is the desire of issuers to flag projects which they are undertaking which have a positive environmental impact. They recognise the responsibilities they have to society and the communities in which they do business.
There are sound financial reasons as well. Green bonds can help issuers diversify their investor base by attracting ESG-oriented investors and by helping them issue in different currencies. Strong demand for green bonds also means they attract more attention from investors, leading to better execution metrics in terms of book building.
Aaron Baker, European Fixed Income and Sustainable Bond Strategist, Europe (AB): If the decision to issue a green bond comes from a company's treasury department, it tends to be focused on best execution pricing and investor diversification. But if it's from the chief executive's office, it is often spurred by seeking to forge alignment with public pledges such as those made in conjunction with the Paris Agreement, signalling the company's green credentials, or by a desire to use the proceeds to begin to transition the company towards climate goals.
EF: Clearly, green bonds impose additional requirements on issuers above and beyond conventional bonds. What do first-time issuers findmost challenging about green bond issuance?
Julián Romero, Head of Bonds Syndicate & Sustainable Finance, Europe (JR): The main point of discussion is around identifying suitable projects, given that the proceeds from green bonds are ring-fenced for green purposes. Issuers also want to understand the needs of investors. What do they have to commit to investors in terms of reporting? Are they going to be able to produce high-quality impact reporting on an annual basis?
Green bonds also need the involvement of different actors. In a standard transaction, the treasury department can manage the whole process. With green bonds, you also need strategic buy-in from the CEO's office, marketing and the operational departments that will deploy the funding and gather data for reporting.
AT: For example, with the ADIF-Alta Velocidad green bond, for which we acted as green advisor, the company found that considerable additional work was needed to issue a green bond. They had to form a larger working team for this bond, involving people from different areas at Adif, to explain the process, to identify the eligible projects on its balance sheet and their current stage, to adapt the internal IT accounting system, draw up environmental KPIs, etc.
EF: To what extent does the lack of consensus around defining 'green' projects cause headaches for issuers? I'm thinking particularly of the controversy around the recent Û500 million bond from Spain's Repsol, which will be used to increase energy efficiency and reduce emissions in its refineries.
AT: If you're building wind farms, it's not a problem. With other technologies, it can be less clear cut. But it is clear that the oil and gas sector needs to diversify its business and change to a new business model.
Repsol is proactive in its approach to climate change, with a climate strategy that is aligned with the 2 degrees objective of the Paris Agreement and with the transition to a low-carbon economy. It is proactive in its conversations with investors. It has ESG investors in its equity. It is considered to be a leader in its sector in sustainability terms.
Also, energy efficiency is a recognised activity in the guidance of the Green Bond Principles [GBP], which has become the leading framework for green bond issuance. The projects funded by the Repsol bond will use best available technology to reduce emissions from a specific part of its business - the proceeds will not be used for new facilities or exploration of new fossil fuel resources. Reduction of emissions from existing technologies is crucial and essential to any climate strategy and to the low-carbon transition. The most important thing, of course, is to be transparent. The company provides full disclosure on the use of proceeds and on the underlying projects, and the bond received a second-party opinion from Vigeo, a leading agency.
JR: The point of the green bond market, and the GBP, is that the market should be open to all sectors, as long as issuers are compliant and transparent about the use of proceeds. Then it's a question of letting the issuer explain its story to investors. Some of these investors felt the bond was not green enough, but others were satisfied.
EF: There appears to be no shortage of demand for green paper from investors. What's driving this demand?
JR: The green bond market has at least two particular attractions for fixed income investors. First is that it allows them to invest for a purpose. That was not explicitly possible before. A growing number of institutional investors have issued green bond mandates to demonstrate that they are seeking to align their investments with sustainability objectives, particularly the 2015 Paris Agreement.
Second, there is a perception among investors that companies that have a greater awareness of the sustainability agenda are likely to navigate the challenges of the future much better. Meanwhile, there are also regulatory pressures, such as Article 173 in France [which requires investors to disclose how they are addressing environmental risks in their portfolios].
AB: In addition, there is also a demographic effect at work. Among Millennial retail investors, more than 70% have stated that climate is one of the goals of their investment strategies; for investors above 50 years old, that figure is under 20%. That's driving a lot of retail flow which in turn is shaping investment mandates from the bottom up.
Also, we can't understate the importance of Paris in catalysing global interest amon g investors in climate as an issue. In the past, this interest was very equity-led, but investors are now looking at parlaying their climate commitments via their bond mandates.
Especially for investors with long-term investment horizons, such as life insurance companies and pension funds, green bonds are seen as a way to mitigate climate change impacts - such as the frequency of weather-related natural disasters - and transition risks, such as the danger that carbon-intensive assets they own could be left stranded by government policies to reduce emissions.
These elements are all combining to provide a tailwind for investment in green bonds. But, if you look at investor surveys, the number one complaint is a lack of green paper. There is insufficient issuance to meet demand.
EF: How does this imbalance of supply and demand affect market dynamics? It must create challenges for investors.
JR: There is a bigger pool of investors. A big majority of those investors are buy-and-hold. The size of transactions also tends to be smaller than comparable conventional bonds. These factors are making pricing tighter - and they certainly make green bonds very appealing for issuers, in that they make execution less risky.
AB: In the secondary market, green bonds generally price inside the issuer's conventional curve, but they are anchored to that curve. Green bonds tend to have a lower beta, because the turnover of green bonds tends to be significantly lower; 40-70% lower, depending on the bond and the issuer, versus conventional bonds from the same issuer.
The more limited turnover in the secondary market is one of the reasons we get such strong bids for primary green bonds. So, for managers building green bond funds - a fast-growing part of the market - you need to source most of your exposure through the primary market.
To help investors trade green bonds in the secondary market, we have started sending out 'green runs' - lists of green bonds either in our trading inventory, or which we're interested in acquiring.
JR: For the immediate future we expect to see continued growth in both supply and demand. We are seeing more issuers in general, and more industries coming to the market, giving investors potential to diversify their portfolios. If you look at the sectors issuing green bonds, it's still a limited number, which causes some concentration bias in portfolios. Everyone is working to bring in new issuers and satisfy investor appetite.
EF: What questions are investors asking about the green bond market?
JR: In addition to conventional credit analysis, investors also carry out sustainability analysis on green bonds. They will want to look at the underlying projects involved, and be comfortable that the bonds are in line with their own internal green investment policies. They also tend to be interested in understanding how much quantifiable impact the bonds have - what the difference is between the green and nongreen alternatives.
AB: One of the big questions I get on the research side is about the comparability of green bond programmes. At the moment, there are about 10 providers of so-called second-party opinions on the environmental credentials of bonds issues, as well as six green bond indexes. They all have different methodologies and definitions of green.At the same time, the emission reductions generated by underlying projects are often calculated from different base years from issuer to issuer, so it can be challenging for investors to map what they are getting to their own climate goals.
Where investors have green bond mandates, they will have key performance indicators [KPIs] that they are looking to meet - for example the carbon reductions achieved for every million euros of investment - and those KPIs require information from bond issuers in order to onward-report to their own investors.
EF: To what extent is the growing consensus around aspects of market infrastructure - such as the Green Bond Principles - making life easier for both issuers and investors?
AB: The big takeaway from the 2017 update to the Green Bond Principles was how little changed. It's a positive development: it's not helpful if the market standard keeps changing, as that can lead to legacy assets which qualified under earlier versions of the principles no longer being eligible. The principles are now a rigorous standard for green bond architecture; that doesn't imply standardisation, which can work against innovation, but it does contribute to comparability.
AT: We saw the importance of the principles with the recent Avangrid green bond that we helped structure. It was key that the issuer followed the guidelines and the recommendation to use a secondparty opinion. We saw it in the order book: investors are very familiar with the GBP approach, and were reassured by the second-party opinion.
EF: What about the role of government? Is there a case for government intervention to help the market continue to grow?
AB: Top-down direction has been very important outside of Europe. In China, India and Malaysia, for example, the market has been regulated from the start. They provide examples of how governments can encourage the uptake of green bonds.
But even in Europe, there are things government could usefully do. The European Commission, for example, is examining using a 'green supporting factor' that would provide regulatory capital relief for banks making qualifying loans, such as those for green buildings. That could encourage greater issuance.
Another factor is the additional incremental costs in issuing green bonds. Governments could help subsidise those costs. In Singapore, the government is subsidising the cost of second-party opinions in inaugural issues, for example.
Finally, governments could use some of their own capital to help improve the risk-adjusted return of underlying projects. By helping to reduce the threshold to get projects financed, we could see real impact in terms of getting additional green projects funded that wouldn't go ahead without the green bond market.
BBVA and sustainable finance
BBVA has been involved in the green bond market since its inception in 2007, having participated in the European Investment Bank's first Climate Awareness bond.
BBVA has played an important role in the development of this market and has structured and placed green bonds from issuers in a number of different market segments. The bank was the most active Spanish financial institution in the green bond market in 2016. In 2017, BBVA acted as a sustainable structuring advisor for green bonds from issuers including SSE, Avangrid, Repsol, Comunidad de Madrid and ADIF AV.
Since 2014, the bank has created a green bonds group within its capital markets business comprising green bond specialists in origination, syndication, trading, sales and research. The group brings together intelligence from all parts of the capital markets value chain to provide a seamless, high value-added service for issuers and investors.
BBVA is also a leading player in the booming green loan market, having closed different landmark transactions in 2017. BBVA expects to see growth rates in the green loan market similar to those achieved in the green bond market a few years ago.
Julián Romero, Tel. +44 (0) 207 397 6125Ê
Aaron Baker, Tel. +44 (0) 207 648 7580
Angel Tejada, Tel +34 91 374 65 37