11 February 2020
In part, the increasing gap between supply and demand in the market for sustainable paper highlights the continued evolution of sustainable finance and the terms used to describe it. Just as the global fixed income market cannot be called simply “the bond market”, opportunities for exposure to sustainable finance can no longer collectively be referred to as “the green bond market”.
London Stock Exchange stands at the forefront of a movement designed to address this imbalance and has developed new opportunities to bring together issuers and investors who wish to create impact. These build on a well-established track record. London Stock Exchange, after all, was the first major global exchange to launch a Green Bond segment in 2015, which required an external review to certify the bonds were aligned to the International Capital Market Association’s (ICMA) Green Bond Principles.
As well as providing UK borrowers access to extensive pools of liquidity looking for responsible investment opportunities, this has played a decisive role in extending the global reach of green bonds. Several companies from China, India and the Middle East have since listed eligible bonds on the segment. More recently, Chile became the first sovereign issuer from the Americas to issue green bonds, listing its inaugural dollar and euro transactions on London Stock Exchange’s International Securities Market in 2019. This January, a Kenyan company listed the country’s first international green bond, partially guaranteed by GuarantCo, in London to fund clean, safe and energy efficient accommodation, and Chile tapped its 2019 issuance and listed a new green bond.
As innovation intensifies, with a broader universe of borrowers, use-of-proceeds and asset classes, historical definitions are being outstripped by developments. “A focus purely on green bonds does not present the full picture,” according to Elena Chimonides, Product Specialist, Fixed Income Primary Markets at London Stock Exchange.
The Launch of the Sustainable Bond Market
Responding proactively to these important shifts, London Stock Exchange undertook an extensive consultation process in the summer of 2019 asking stakeholders for their views on changes to accommodate a wider spectrum of borrowers and instruments. The result was the launch of London Stock Exchange’s Sustainable Bond Market (SBM) in October 2019, which establishes two distinct areas of eligibility for admittance.
The first is aimed at formalising the broadening use of proceeds classification, by adding social and sustainability segments alongside green bonds. These are labelled as such by observing principles and taxonomies established by ICMA, and other recognised equivalent local or regional standards such as the EU and ASEAN Green Bond Standards. As London Stock Exchange announced at the time, “these new segments further enable investors to distinguish between different types of sustainable bonds, based on independently verified frameworks and use of proceeds.”
The Rise and Rise of Social and Sustainable Bonds
The wider segments reflect the increasingly pressing need to accommodate instruments from issuers from a broad cross- section of the economy. There were several notable examples of innovative transactions of this kind in 2019, led by the £350 million 22-year bond from Yorkshire Water in April, which was the first sterling-denominated sustainability bond and the first of its kind from a UK corporate borrower listed on London Stock Exchange. It was also the 100th active green, social and sustainability bond listed on the London’s Green Bond segment.
The following month, Co-Operative Group chalked up another first when it printed the first sterling-denominated sustainability bond from a UK retailer. An innovative feature of this £300 million five-year issue was that the proceeds were allocated for supporting the sale of Fairtrade products, thereby supporting farmers and artisan producers, chiefly in developing countries.
Another landmark issue for London last year was the inaugural Social Bond by Royal Bank of Scotland (RBS) issued in November 2019, which was the first of its kind by a UK financial institution. This ground-breaking €750 million (£650 million) senior unsecured transaction was the first to be launched under the bank’s new framework forming the basis for issuance of green, social and sustainability bonds. Proceeds are earmarked for lending to SMEs in economically deprived areas of the UK economy.
The Issuer-level Segment
The second distinct area of eligibility for listing on the new SBM is an issuer-level classification. “Recognising that so many companies are starting to look holistically at their general sustainability strategy, we launched a new segment catering to issuers whose core business activity is aligned with the green economy,” Chimonides explains.
Shrey Kohli, Head of Debt Capital Markets and Funds at London Stock Exchange, adds that the eligibility criteria for admittance to the issuer-level segment were determined in close consultation with investors. “We asked green bond and specialist ESG investors about how they fill their green-linked portfolios,” he says. “Many of them told us that with portfolios of $1 or $2 billion investing over 5-10 years, there are not enough assets available in the traditional green bond market.”
“Investors said that they use taxonomy data from their own research or from external providers to identify issuers’ green revenues,” Kohli adds. “They are then comfortable with buying the plain vanilla debt of issuers whose green revenues are above a certain minimum threshold.” While preferred minimums varied among respondents, London Stock Exchange has set the bar relatively high, admitting companies to SBM with more than 90% of revenues defined as green. Such issuers on SBM include, Severn Trent, United Utilities and Pennon Group – all being environmental infrastructure and water companies in the UK.
Protection for investors in the new market, meanwhile, has been strengthened with the introduction of mandatory post- issuance reporting requirements for issuers on SBM. Aside from providing investors with enhanced transparency on the ongoing use of proceeds, this will verify continued eligibility for inclusion on SBM over the lifetime of eligible bonds.
“With 215 instruments admitted by the end of 2019 raising more than £37 billion, the success of SBM speaks for itself,” says Chimonides. “The issuer-level segment will allow us to potentially admit sustainability-linked bonds in the future,” adds Kohli referring the establishment of an industry working group on sustainability/ KPI-linked bonds.
A similarly flexible philosophy that underlies the establishment of SBM in the fixed income market has driven a key recent initiative announced by London Stock Exchange in the equity market. Dovetailing with the launch of SBM in October was the announcement of the new Green Economy Mark. This recognises issuers from all segments of the Main Market and AIM deriving 50% or more of their total revenues from products and services that contribute to the global green economy. “The 50% level ensures that the Green Economy Mark captures not just those in obvious areas such as renewable energy, but companies whose products and services directly contribute to a sustainable low-carbon economy across a wider range of sectors,” says Chimonides.
Chimonides adds that in assessing which companies are eligible for inclusion in the Green Economy Mark, London Stock Exchange is harnessing the capabilities of the wider London Stock Exchange Group. These include data and index provider, FTSE Russell, which has developed key benchmarks such as the FTSE4Good, designed to measure the performance of companies demonstrating strong ESG practices, and the FTSE Climate-WGBI Index, which balances the World Government Bond Index based on sovereign climate risk.
Both in debt and equity, Kohli says that the requirements for issuers to comply with certified principles or green revenue methodologies consistent with globally recognised taxonomies provides investors with an important safeguard against the risk of greenwashing.
The Growth of Green Investment Funds
Another area in which London Stock Exchange is committed to expanding long-term opportunities for sustainable capital raising is in the investment funds sector. Kohli says that of approximately £7 billion raised in the market for closed-end investment trusts in 2019, about a third was accounted for by vehicles with specific green or renewable mandates. These include companies such as the Renewables Infrastructure Group (TRIG), which manages a portfolio of energy industry assets in Europe, and raised £530 million of further capital in 2019, and the Octopus Renewables Infrastructure Trust (ORIT), which specialises in wind and solar assets, which raised £350 million in its December IPO, a large component of which was from retail investors.
“Such funds recognise the importance of the need to channel long-term capital into projects which may require 15 or 20 years before they become cash-generative,” says Kohli. “At the last count, of 76 green economy companies listed in London, 23 are investment fund strategies focusing on areas such as renewables, energy efficiency and battery storage. As these sectors mature, there is no reason why they shouldn’t attract more capital via structures other than debt, opening up new funding opportunities for corporate treasurers, and for investors looking for the right risk return premia.”
Exploring the Potential of Transition Bonds
Underpinning its recent initiatives to accommodate more shades of green and brown is London Stock Exchange’s conviction that if the private capital required to address the climate change challenge is to be raised speedily and efficiently, investment support must not be confined to issuers operating purely in sectors perceived to be green. Kohli says that this is in line with the findings of an influential white paper published last summer by AXA Investment Management which called for the development of a new market for so-called transition bonds. “While green bonds are intended for issuers to use the proceeds to finance environmentally-friendly projects, we see a significant gap where investors could step in and deliver real impact for companies which are not yet at this stage,” AXA explained.
“There is an opportunity to provide finance to companies, which are ‘brown’ today but have the ambition to transition to green in future,” it added. “This includes firms that are not able to issue green bonds today, due to a lack of sufficiently green projects for which they can possibly use bond proceeds.”
Kohli says that in its consultation with the market on the potential for transition bonds, London Stock Exchange proposed to define the instrument as an asset class based on three clear metrics. “Issuers would need to have a cogent sustainability strategy at the company level, some form of independent verification of that strategy and objective targets for measuring its results based on science-based frameworks,” he says.
Transition: Not a Contradiction
Kohli adds that the responses London Stock Exchange received from more than 40 financial institutions to its paper on transition bonds suggest a recognition of the importance of transition, a key theme of the UNCCC COP 26 hosted by the UK in November, but that the jury is still out on how this asset class will evolve over the long term.
Nevertheless, the long-term trend of specialisation within sustainable finance supporting broader access is unmistakable. The establishment of a Climate Transition Finance Working Group through the Green Bond Principles is a recognition of this.
London Stock Exchange has already built an enviable track record in sustainable finance for green finance as well as other sectors. Twinned with its forward-looking initiatives aimed at deepening and diversifying the market, and anchoring sustainable finance at a strategic level for its listed companies, this means London Stock Exchange is ideally positioned to capitalise on its position at the heart of London’s vibrant financial hub to accelerate the transition towards carbon neutrality. “As one of the world’s largest financial market infrastructure groups, we are fully committed to supporting innovation in sustainable finance backed by the most robust standards of transparency and disclosure,” says Kohli.