Sovereigns, sustainability and CRR: Looking ahead to 2020

Channels: Green Bonds

Companies: BBVA

People: Michael Gaynor, Patricia Cuenllas

The ESG bond market is set to continue its strong growth in 2020, says BBVA, with sovereigns and financials leading the way, while the market grapples with the challenges and opportunities of sustainability linked bonds. BBVA, as a frontrunner in the sustainable and green bonds space, helped underwrite 30 green, social and sustainable bonds in 2019, and is the most active issuer among Spanish financial institutions.

Environmental Finance (EF): Last year you predicted $220 billion in green bond issuance in 2019, which was a bit of an underestimate, in the end. What's your figure for 2020?

Michael Gaynor, Financials, ESG and Covered Bonds Analyst, BBVA Global Markets Research: Michael Gaynor, Financials, ESG and Covered Bonds Analyst, BBVA Global Markets ResearchWhen we came up with our $220 billion figure, we were actually above market consensus by quite a long way – and the year itself surprised on the upside. Our numbers suggest just under $250 billion globally in ESG bond issuance. What drove that surprise was more issuance from western European issuers than we expected.

Looking forwards to 2020, we expect global issuance of ESG bonds to reach around $320 billion. That growth is coming from two major sources: European financial institutions and sovereigns. The former are subject to the second iteration of the Capital Requirements Regulations. CRR2 is basically introducing a more stringent set of capital requirements to European institutions, the upshot of which is that banks need to issue more capital instruments over the next three to four years, and more banks are interested in doing this in an ESG- labelled format.

The second thing that's piqued our interest is the role that sovereign issuers are going to play in 2020. A number of sovereigns are already catching our eye: Spain, Germany, Sweden, Denmark and Italy – we expect all of these names to come to the market in 2020, as well as Portugal, potentially. We see Europe as the main driver again for the market this year.

Within the corporate space, we expect to see issuance from the telecoms sector, but also continued issuance from utilities as companies continue to take advantage of strong investor demand for ESG-labelled paper.

EF: What's behind greater interest from sovereigns in tapping the market?

MG: Investor demand is the key thing. The French sovereign bond was very well received, and other sovereign issuers have done well in terms of the demand side. Investors are looking for a more diverse issuer set that would, in turn, provide more opportunities for trading, more volatility and more opportunities to exit positions. Clearly, it would be helpful to these guys to have more ESG bonds in their sovereign portfolios.

You have to remember that it's the investors who have driven this market. Whether in terms of demanding disclosure from issuers, data from the data providers, interventions from the regulators, they've really driven a large number of the initiatives that we've seen in the green bond market so far, and that's true in the sovereign space as well.

In our conversations with some of the sovereigns that first approached the market, they faced budgetary or even constitutional issues regarding their ability to ring-fence proceeds from individual bonds for green purposes. These issues have been resolved, and ring-fencing isn't the issue that it was in the past.

There have also been some issues on the buy side: while investors have quite advanced ESG scoring methodologies for corporates, for sovereigns, ESG second-opinion providers have found it more difficult to provide ESG scores for countries. What is the right way to determine if an ESG bond from one country is better than another? Hopefully, with more sovereigns joining the queue, and with the World Bank planning to launch a portal with country-level information, we are seeing some progress here.

EF: What are you seeing in terms of how corporate and financial issuers are approaching the green bond market?

Patricia Cuenllas, DCM, Sustainable Bond Group: They may be on the smaller side in terms of capacity compared with sovereigns or financials, and following a record year in terms of issuance, but we are perceiving increasing interest, with a large number of companies from a range of sectors looking into these markets.

We're really moving from a niche market into the mainstream. Senior management are asking their financial departments to look into the sustainable bond market to see what opportunities there are. We've seen more and more corporates reaching out for meetings, wanting to know more about the market, to understand the options available, whether they have the appropriate projects and assets to allow them to participate. There is also a presentational driver: companies want to use the green bond market to demonstrate, both internally to their staff and externally to investors, regulators, etc. that they are undertaking projects and investments that have a positive environmental impact and to underline the alignment of their funding strategy with their sustainability strategy and objectives.Patricia Cuenllas, DCM, Sustainable Bond Group

Companies are increasingly aware that the ESG bond market opens them to a different investor base. On the other hand, it's also true that they are aware that they need to be very careful when tapping the market, in that they don't want to expose themselves inadvertently to reputational risks as a result of triggering some controversy. It's not just a question of setting up the appropriate framework and commissioning a second-party opinion, there can be complexities with the various categories of green bond. With energy efficiency, for example, it's not immediately clear which way investors look at projects in this category; issuers need to be sure there's not going to be any controversy attached to these issues, in how the project is presented, how it is developed, and how it fits with the company's broader sustainability strategy.

We are optimistic about this year for sure in the corporate and financial space. With the corporates, we have seen that this year the issuers will have spent time on their structuring processes; they realise that quick exercises are not typically sufficient to explain long-term company strategy. Issuers are willing to spend time on this structuring, in order to be able to launch a green bond framework that will work in front of the investor community.

We are also very optimistic about categories of bond linked to the circular economy. We expect to see corporates looking to explain how they and their products support the circular economy. We will also see new ICT issuers, given the success of issues from Vodafone, Verizon and Telefonica.

Moving to currencies, we've seen how big US dollar investors are really starting to set out their strategies around ESG, which will drive increased demand for US dollar green bonds. So we expect to see not only US dollar ESG bonds from US corporates but also from European issuers looking to tap the US dollar market.

Last but not least, we expect Latin American issuers to be more active in 2020. Market conditions were tough in 2019, but we've been in active dialogue with clients in the region. Public issuers, in particular, are keen to support local ESG bond markets and help them grow, but we also anticipate Latam companies to issue hard currency-denominated green and sustainability bonds.

EF: What about sustainability-linked bonds? What impact do you see them having on the market?

PC: Unlike the loan side of the market, green bonds have tended to follow the use-of-proceeds model, rather than being linked to a company's broader sustainability objectives, but this year for the first time we've seen a sustainability-linked bond [from Italian utility ENEL]. Market participants, including issuers and investors, sustainability agencies and even the Green Bond Principles, are analysing the impact of this new bond class, and are considering their positions. So, we are hearing many voices for and against this format and, for sure, this year is going to be key in terms of how that part of the market develops.

Looking forwards to 2020, we expect global issuance of ESG bonds to reach around $320 billion

EF: What advice would you give to a client that came to you with a view to structuring a sustainability bond?

PC: We certainly have the capacity to support our clients in their transition to a low-carbon economy and the transformation of their businesses, so we would sit down with them and analyse and assess what their expectations are, and what investors are willing to see in the fixed-income ESG market. We obviously have our own internal assessment about this new format, and our priority is to maintain the environmental integrity of the market.

The green bond market has been built on the pillars of transparency, environmental integrity, monitoring and reporting. Investors in the sustainability bond market continue to have those expectations, meaning that clients have to be transparent in the approach they take, to explain the exercise, to explain their strategy going forward and how it fits with the sustainability financing arena.

We expect some guidance on this question to emerge from market participants. For this part of the market to grow, everyone will need to work according to this format. So we expect that this type of bond can complement issuers' funding needs, but the market needs more time to reach consensus on the way forward. For example, as members of the executive committee of the Green Bond Principles, we are looking at the possibility of being involved in the discussion somehow.

MG: From a research standpoint, when I saw this structure come out in September, it was incredibly ambitious from the issuer perspective, and it raised a lot of interesting questions from investors as well. It is a whole different view of this marketplace. This market was built on the very transparent reporting around use of proceeds, which is exactly what we don't have with regard to this kind of instrument.

The issuer in this case is a well-known company in terms of its ESG standpoint, meaning that investors could get comfortable with this structure. Potentially, we're going to see issuers that aren't well-known in this space look to issue sustainability-linked bonds. In the short term, we think that these types of issuances are going to complement use-of- proceeds bonds: they'll form a part of this marketplace rather than cannibalise it.

But it's interesting from our perspective to see these innovative structures come forward, the feedback was good, and investors do want to see instruments of this kind, because what they do is they align corporate strategy with sustainability goals, pinning wider corporate objectives to sustainability targets.

This is attractive to dark green investors, who want to see that level of commitment from issuers. We expect more of these types of bonds to come forward this year.

BBVA is very committed to these markets, and we plan to continue to be active in the green and social bond market arena, both as an issuer and as partner for our corporate and institutional clients

EF: Moving on to the EU's sustainable finance taxonomy, are you supportive of the approach the EU has taken, and what impact do you expect it to have on the market?

MG: We're 100% supportive. We were encouraged by the initial drafts, and the final report itself was a positive surprise. What surprised us was first the level of detail. This was a vast piece of work, in terms of the sheer number of pages and the technical detail that it went into. The signal that conveyed to the market was that this is a very ambitious, very detailed and incredibly serious project that has been undertaken. So we're optimistic, and we're looking forward to what is to come.

There are some wavering concerns, I would say. The key thing for us is the legislative vehicle by which the taxonomy will be placed into European legislation – how will this become binding in European law. The European Council, Parliament and Commission have arrived at the basis of an agreement following months of negotiations. However, there is still some way to go in having a fully implemented Taxonomy. There is also still a lot more work to do; the taxonomy so far has only addressed two of the six environmental objectives [climate change mitigation and adaptation] – the remainder will take time. We're optimistic, we're happy with what we've seen so far, but let's keep up the good work.

EF: Moving on to BBVA itself, you issued your second sustainability bond last year, how was it received by the market – and what's next for bond issuance from the bank?

PC: We used the same SDG bond framework that the bank published in 2018 [which allows proceeds to be directed towards projects which promote one or more of eight of the Sustainable Development Goals]. We are very happy with the outcome, in that we have seen increased diversification in terms of green investors coming onto our books. We used the SDG framework to issue from Spain, with two euro bond transactions, from Mexico, with BBVA Mexico issuing a $300 million bond last year, and from Turkey, with a $50 million dollar private placement this year.

Our commitment is to issue at least once a year in this market, so the bank is analysing our balance sheet for opportunities. To be able to tap this market, you have to have sufficient underlying business to which to direct ESG bond proceeds. We are always talking to our origination teams, from finance, energy, real estate, even retail, all analysing how we can promote sustainable finance to our clients.

As a general comment, BBVA is very committed to these markets, and we plan to continue to be active in the green and social bond market arena, both as an issuer and as partner for our corporate and institutional clients in their sustainable journey.