09 January 2018
More than $100bn of green bonds were issued globally in 2017, up from around $80bn in the previous year. But market participants now need to analyse more complex sectors and broaden out the use-of-proceeds from the "low-hanging fruit" for growth to continue at this pace in 2018, particularly in the corporate space, Citi's Philip Brown and Courtney Lowrance explain.
Environmental Finance (EF): Despite 2017 being a strong year for green bonds, corporate issues still make up a fairly small share of the market. What are the main concerns holding corporates back from issuing green bonds?
Philip Brown, Head of SRI Bond Origination: We've seen good growth in the market this year, to comfortably over $100bn of green bond issuance. Corporate issuance grew in 2017, but one reason it's not growing faster is that many corporates who would like to issue feel nervous about entering the market. They feel a high degree of uncertainty around whether or not they have eligible assets which can be financed or re-financed with a Green Bond. There's still a lack of accepted taxonomies out there, defining what is Green across different asset classes and industries. ESG considerations are increasingly central to the strategy of many industrial corporations and Green Bond issuance aligns closely with the growing recognition by CFOs and Treasurers that ESG scores matter to investors. Issuing a green bond is an effective way of increasing the transparency of issuers' environmental policies and priorities. However, the lack of clarity around what constitutes a green asset is problematic. The range of assets widely accepted as Green is still limited today, which encourages issuers and bankers to be cautious about financing new asset classes in the Green Bond market. No issuer wants to risk their reputation by issuing a bond which is rightly or wrongly criticised for being insufficiently ambitious or transformational from an ESG perspective. This fear is particularly applicable for the many industries for which there are no widely accepted definitions.
EF: If uncertainty around what's green is holding back issuance, how can this be overcome?
Philip Brown: As many corporates feel constrained by the requirements of the green bond market, we are seeing a significant move towards the adoption of the UN Sustainable Development Goals (SDGs) as a more inclusive way forward which can encompass a broader range of use-of-proceeds. Climate remains by far the dominant theme for investors, but a broader, more inclusive approach to Sustainability is going to become more dominant going forward. We recommend that Issuers map their Green Bond Framework to the SDGs as we're increasingly seeing the investor community do so.
The green bond market is also constrained by the capacity of the most widely used Second Party Opinion Providers. SPO providers do a great job, but their resources and expertise across different industries is limited. I see a bigger role for environmental consultants working with issuers to bring their specialised knowledge to investors, helping them understand relative environmental improvements across global industries and specific geographies. Debt Capital Market practitioners, whether bankers or investors, don't have the level of expertise needed to define an appropriate transition path to a 2 degree world across different sectors.
The Climate Bonds Initiative (CBI) does a fine job in this regard, with their inclusive approach, gathering views of technical experts and industry practitioners across different sectors. The capital markets have to rely on the scientific community to guide us in the right direction to define what is Green.
Courtney Lowrance, Global Head of Environmental and Social Risk Management: It takes environmental expertise to understand the entire ecosystem and life cycle of green assets. You have hydro power, for example, which is low-carbon but there can be significant environmental and social trade-offs.
Over time we are seeing a harmonisation of standards which helps build greater consensus on what we consider green. The CBI is at the centre of that. However, we won't achieve 100% consensus because of the different development trajectories seen across different markets. When you look at Asia and compare it with Europe and North America, the definition of green is very different because some interventions can have much greater impact in Asia. I'm not suggesting different geographical standards, which would just confuse the market. However, I do think we need to consider the context when defining green.
On the issuer side, we're seeing that issuers often overlook their broader ESG profile. A corporate's ESG profile is becoming more and more important to investors, both in green and traditional bonds. That's another way in which we can help issuers since we have 15 years of expertise in ESG integration.
EF: What is the potential for sector diversification in the corporate green bond market?
Philip Brown: Corporate green bond issuance is still heavily tilted towards the renewable energy and utility sectors. If we're really going to make a difference and influence decision making in the broader corporate world, the market has to become more than a wind and solar bond market. The key is to define a Transition Path to 2030 across the full range of industries. All sectors need to be involved. I'd like to see green bond issues from sectors such as shipping, autos, airlines, cement, metals and mining, and selectively from the hydrocarbon industry, all of which have an important role in the transition path. For the market to grow and mature in 2018 we need to address some of these complex asset classes.
The green bond market today has so far worked on the assumption that only capex should be financed, but I'm supportive of the idea that green bonds could also finance appropriate operating expenditure, for example renewable Power Purchase Agreements. This is all part of a more inclusive focus on the transition path and not jumping to the end game.
The Development Bank community also has an important role to play, as they have a substantial depth of environmental expertise. They could perhaps expand the range of eligible assets within their own green bond issuance. Similarly, Governments have a role to play, not only as issuers, but in prioritising and financing greater research into the transition path of the global economy towards achieving the goals of the Paris Accord.
Courtney Lowrance: We've been having discussions with potential issuers in more complex sectors, for example in shipping and aviation. In shipping there's a huge opportunity to lower emissions by converting ships to run on LNG. The shipping industry accounts for just 3% of global GHG emissions currently, but that is expected to rise significantly by 2030. Converting the existing fleet from bunker fuel to LNG-powered vessels will be key to decarbonizing the sector.
We're also really excited about bringing industrials into the market. Our view is that you have to engage the entire economy in order to solve climate change, so we work a lot around the building of tools that incorporate environmental factors into financial models. We've worked a lot on water and modelling the financial benefit of investing
in water efficiency as well as the impacts of drought scenarios on credit profiles.
I expect we will see increased market activity in agriculture. We're working with corporates in Indonesia and Peru on reducing deforestation, and the issues by Klabin and Fibria in Brazil really moved the needle on how the market looks at biodiversity. I hope we see more green bonds focused on land use because it's a really important area for tackling climate change.
EF: What is needed to convince sceptics that the likes of heavy industrials and shipping companies can issue green bonds? How do you avoid controversy around more complex sectors?
Courtney Lowrance: These are complex sectors and that's why it's so important to have strong environmental expertise in order to model the impact of green bonds in these industries from a climate perspective. My team is doing a lot of work on 2°C scenario analysis. We're now working with the UNEP Finance Initiative and Oliver Wyman to build scenarios that show the impact of policy and technology on various sectors.
We've already done a lot of similar work in oil and gas and plan to do so across a range of other sectors. EF: What are your expectations for the corporate green bond market in 2018? Courtney Lowrance: My prediction is that 2018 will be a year of complexity. We're starting to move beyond the low-hanging fruit, and engaging all sectors of the economy will be key in the transition towards a low-carbon world.
Philip Brown: I also see next year as year of complexity and maturing of the market. Many corporates looking to come to the market who are managing complex assets. Barely a week goes by without question from a new corporate in a new industry asking 'do we have appropriate assets on the balance sheet'.