Green bonds have completed yet another record year, and our estimates predict further growth of the segment. Issuers from Europe will be in the driver's seat in 2018 in our view, after more than half of all green bonds came from Europe this year. However, as the green bond market evolves further, its critics are also becoming louder, writes UniCredit's green bond team.
With USD 111bn in new issue volumes, 2017 marks another record year for green bonds, surpassing 2016's total of USD 92bn. "We are confident that the green bond market has more potential to grow," says Antonio Keglevich, head of Sustainability Bond Origination at UniCredit.
"For 2018, we expect new issuance volumes of USD 130bn. Part of this will be the refinancing of outstanding green bonds as it is likely that the majority of the USD 10bn of green bonds maturing next year will be refinanced with new green issues." This means that USD 120bn of our estimate will be made up of new issuance, according to UniCredit's estimates.
Green bonds are now more than ever a European market
Over one half of new issuance this year has come from the EMEA region. Asia Pacific ranks second, led by strong issuance from China, while the Americas rank third in terms of regional issuance.
The single largest green bond ever came from the Republic of France at the beginning of the year. The French green sovereign bond, issued at the end of January 2017 (FRTR 1.75% 06/2039) currently has close to EUR 10bn outstanding after it was tapped twice this year, in May and in December 2017. "Europe will also provide an important impetus for market growth in 2018," says Robert Vielhaber, green bond analyst in UniCredit's research team. "Some countries stood out this year, namely France, Germany and the Netherlands. They saw an array of utility companies, banks as well as government agencies coming to the green bond market." France, Germany and the Netherlands are the three largest countries in Europe in terms of green bond issuance this year.
In Germany, it has been the banking sector that has been particularly active. A number of German mortgage lenders are using green bonds to fund energy efficient buildings. Berlin Hyp and Deutsche Kreditbank (DKB) issued green bonds in senior unsecured format this year. We also note an active market for green covered bonds, with a repeat issue by Berlin Hyp.
In fact, Berln Hyp issued two green bonds in 2017, a green covered bond and a green senior unsecured bond. It is now the most active bank in Europe after issuing two green seniors and two green covered bonds for a total outstanding of USD 2.3bn.
Meanwhile, German mortgage lender Deutsche Hypothekenbank issued its inaugural green Pfandbrief, officially making it the second ever issuer of a green Pfandbrief, after Berlin Hyp. The bank used the proceeds of the EUR 500mn transaction to finance mortgage loans secured by commercial real estate in Europe. Deutsche Hypo's green Pfandbrief is a pure use-of-proceeds bond clearly defining the purpose of the funds raised.
In our view other, larger banks in Germany may find green bonds, be it in senior unsecured or covered format, increasingly appealing in 2018.
Other European nations have some catching up to do
Other European nations have some catching up to do. It is likely that they will do so in 2018: Austria's banking sector saw one green bond and one social bond this year, issued by Hypo Vorarlberg and Kommunalkredit Austria respectively, and we expect others may follow the lead.
It has to be noted that Austria had a head start to green bonds with a EUR 500mn transaction from renewable energies utility Verbund back in November 2014.
Meanwhile, the UK made some strides in terms of green bond issuance this year. Utility company Anglian Water became the first UK corporate with a benchmark-sized green bond this year, swiftly followed by a further utility company, SSE.
With Barclays, the first UK bank completed a green bond in 2017. The same holds true for Switzerland, where issuance volumes were persistently low, but the canton of Geneva recently showed nicely that green bonds from the country work, with a CHF 200mn transaction completed in November to finance energy efficient buildings for health services and medical research.
Green bonds will undergo a transformation in 2018
It is fair to say that green bonds will undergo a transformation in 2018, not only from a regional point of view, but also in terms of sectors. Utilities are the largest green-bond issuers this year: Green bonds from utilities make up 24% of all new issuance in 2017, ahead of banks (23%) and government agencies (14%). This shows that the market has diversified away from the days of multilateral development bank and government agency dominance.
In our view, green bonds will transform further in 2018 – to a market driven by corporate and financial issuers. Utilities and banks will take the lead. This year's utility issuance has been spearheaded by Spain's Iberdrola and Dutch grid operator Tennet, as well as by Italian utility Enel and multi utility IREN. Innogy became the first German utility company to issue a green bond, a EUR 850mn transaction in October 2017. Most recently, Spain's Gas Natural completed an EUR 800mn green bond at the beginning of November. This shows that utility companies will take the lead in terms of new green bond issuance in 2018. Europe's banks make up the second pillar of the transformation. This is a change from 2016, when Chinese banks dominated the market. This year, the focus was clearly on European commercial banks. In addition to the aforementioned German mortgage lenders, Sweden's SEB, Swedbank and SBAB, as well as Credit Agricole, Intesa Sanpaolo, HSBC France and Barclays all issued green bonds in 2017.
In 2018, green bonds must stand up to criticism
With the market for green bonds not only growing, but also transforming, criticism of the use of proceeds format also becomes louder.
In particular the refinancing of existing assets with a green bond has been subject to controversial discussion. A number of green and social bonds that have come to market have done exactly that – refinance assets that already exist.
Examples include the aforementioned mortgage lender Deutsche Hypo or Italian multi utility Iren. Deutsche Hypo for example stated that it will use the proceeds of its recent EUR 500mn green bond to refinance 48 energy efficient buildings. Italy's Iren used a green bond towards the refinancing of various projects and assets in the fields of renewable energy, energy efficiency, waste management efficiency and recycling and waste water treatment.
Using green bond proceeds for the refinancing of existing projects is also common for sovereign and sub-sovereign issuers, who cannot increase their absolute levels of debt. Some dedicated SRI investors have raised the question if the refinancing of existing green assets adds any value under environmental or social aspects.
They claim that the assets already exist – whether or not the green bond is issued. Consequently, commentators are questioning the additionality of a green bond with regards to the environmental, social and governance (ESG) obligations of investors. However, some of the most important stakeholders, and core clients of UniCredit's green bond franchise, hold a differing view: "We think green bonds can also be used for refinancing of existing green projects," argues Bram Bos, a portfolio manager at Dutch asset manager NN Investment Partners, which has several green bond strategies under management.
Bos argues that "in the assessment of a green bond or green bond framework it is less important if the projects are new or existing. The question we ask ourselves is whether the issuance of a green bond is in line with the issuer's strategy or helps the issuer in transition to a cleaner and greener company."
From the point of view of the investor, it is indifferent to finance a ten year green project with a five year green bond which is refinanced after five years with another green bond, as opposed to a ten year green bond for the same project. In addition, the Green Bond Principles (GBP), the set of non-binding guidelines for green bond issuers, clearly state that green bonds can be used for the "refinancing of new and/or existing eligible green projects, which are aligned with the four core components of the GBP".
Raising the bar for post issuance reporting
A further point of criticism that has been arising this year is the post issuing reporting. Rating agency Moody's in a recent study from November analyzed a sample of 17 green bond transactions under their customized green bonds assessment methodology.
The rating agency concluded that ten of them fell short on the reporting and disclosure segment. To be fair, the overall assessment for the sample was labelled excellent. However, an improvement in reporting will be a necessity in the further development of the green bond market, because green bonds rely heavily on the explicit environmentally friendly use of their proceeds for differentiation.
Transparency throughout the entire financing process is therefore key to the market segment. However, post-issuance reporting appears to be flawed for several issuers. "Most of the issuers who fall short in terms of green bond reporting already have questionable ESG policies," argues Bram Bos from NN Investment Partners. "To reduce the risk of buying green bonds where reporting is falling short, it is important to screen the issuer carefully and have a good understanding why the issuer is issuing a green bond." The portfolio manager argues that in general, there is a need for more comprehensive reporting.
With the growth of the green bond market accelerating, it becomes even more important that users are going to use comparable templates for reporting. „With the market developing fast, it is important that standards progress," says UniCredit's Keglevich. One example is the market for covered bonds, where the first green issues defined minimum LEED, BREEAM, DNGB or HQE certifications for buildings to be declared as eligible for the use of proceeds. Back then, energy efficiency was only an additional selection criteria.
Today, SRI investors have a higher focus on energy efficiency certificates, that easily translate into energy savings in numbers in the respective impact reports. "The buildings certificate such as LEED or BREEAM have turned into a nice to have add-on," argues Keglevich.
"If you manage a green bond portfolio with 100 bonds in your portfolio, for example, it is very challenging to go through all of those impact reports," says Bram Bos. "On a positive note we already have seen strong improvements in terms of reporting in the past few years. For example, there is more agreement on what type of impact indicators should be included in the reporting. The underlying methodology how to calculate these impact indicators still needs more harmonization," addsBram Bos.
UniCredit's Green Bond Value Chain
Antonio Keglevich, Head of Sustainability Bond Origination
Max Gottal, Green Bond Co-Captain, Sales Germany
Lars Conrad, Green Bond Co-Captain, Sales Germany
Zoran Marinovic, SSA & Green Bond Trading
Robert Vielhaber, Green Bond Credit Research
Bloomberg page <HVBT> GO / Green Bonds