Green Bonds, what are they all about?
This commentary is intended for professional investors within the meaning of MiFID II
Interview with Marie Lassegnore, Credit Portfolio Manager & ESG Director for Fixed Income and Cross Asset, La Française AM.
Why invest in Green Bonds and what are the advantages?
The first advantage of green bonds is the visibility over the allocation of capital through the ‘use of proceeds’. The green bonds market has been set up around this use of proceeds element which differs from the ‘general corporate purposes’ of traditional issuance. This allows investors to elect which types of projects they are willing to finance. Not only does this introduce a new power in choosing the types of projects but it also comes with a higher level of transparency over the selection and allocation of proceeds and their underlying impacts (through the dedicated impact reports).
Since the early days of the green bond market, which was initially only supported by SSAs (Sovereigns, Supranationals & Agencies), the universe only expanded to utilities and banks a couple of years ago. The lack of corporate diversification had long been an obstacle to replicating an allocation to the corporate market, but we think the latest developments will encourage the arrival of new issuers and further reduce the gap with traditional credit indices.
Green, Social and Sustainable bonds market: breakdown by sector
Source: Bloomberg, La Francaise AM, as at 31/01/2021
With regards to the valuation of green bonds, the market has definitely shown resilience in times of volatility. We can see it when comparing the levels of spreads between the euro green bond market and the euro investment grade one throughout the COVID market stress period from February to July 2020. The green bond indices have held up much better reflecting a somewhat stickier investor base as well as a stronger underlying credit quality protecting the market from the fallen angels wave. The market has also shown increasing signs of a “greenium” which really differs in magnitude from one issuer to another and is not consistent on all maturities of the same issuer. We think that this is the natural result of a market which is still distorted by a greater amount of demand than available supply.
Finally, going beyond the technical aspects behind the opportunities to invest in this market, one should bear in mind that the green bond market, and more widely, the sustainable bond market (which includes Social, sustainable, transition and sustainability-linked denominations), has created a new channel of communication between bond issuers and investors. This is not to be undermined as historically bond investors have had little room for engagement with companies given their lack of voting rights.
Why the recent interest in green bonds?
The reasons behind the recent exponential growth of the market are twofold: the uptick in SSA involvement and the broadening of ESG-labelled debt for corporate issuers. We expect this trend to continue in 2021 and moving forward.
On the government and government related market, the EU has been a driving force of the recent uptick in SSA issuance with their pandemic related social bond program called SURE (Support to mitigate Unemployment Risks in an Emergency). The EU has already issued more than 50 billion euros out of the 90 billion granted to member states. The very strong demand behind the SURE issuance (latest issuance was 9 times oversubscribed) and the view that the ECB would be a persistent buyer in the secondary market has led to a tightening of EU bonds relative to other SSAs.
The 2021 funding outlooks from European countries has also shed light on government issuance, with repeat issuers (like France and Germany) coming into this market or newcomers like Spain or Italy.
The second growth driver comes from the increased adoption of impact bonds by corporates. A wider range of corporate issuers consider raising ESG-labeled capital. Reaching this market has the advantage from the corporate’s perspective, to diversify its investor base, reduce its funding costs risks and message their sustainable strategy. Indeed, fewer green bonds are issued opportunistically nowadays, most of the projects financed by the green/social bonds are part of a much bigger picture of improving the company’s sustainable profile. Another market development which allows the arrival of new issuers, but mainly new industries, is the appearance of Sustainability-linked bonds (SLBs). These bonds are not restricted to use of proceeds but their coupon payment (often the coupon steps up or down) is based on a specific sustainability target. To tie this up with the wider EU green agenda, the ECB has even made those bonds eligible for its buying programs if the targets are environmentally related (usually linked to an emission reduction objective). In our view, this opens the door for companies in carbon intensive industries to finally enter the ‘impact bonds’ market (the first example coming from an SLB issuance from the cement industry).
Do they really represent an opportunity or just a trend?
This is clearly not a trend but an opportunity to participate in the growth of what is to become a structural market for decades to come. The European Commission has put everything in place to normalize this market (EU green bond taxonomy and standard) and will drive green finance indirectly through reporting requirements imposed on European investors (committing and disclosing ESG assets, performance and products). The trend is not limited to Europe as major participants of domestic green bond markets are aligning with international standards (specifically China and Russia) and can bring a new range of issuers.
On the supply side, as explained earlier, corporates have every incentive to catch this train if they do not want to miss the ESG investing wave that is currently ongoing and has shown itself in big numbers in 2020 with investment flows into ESG fixed income funds outpacing the broader market by more than 25% on average. (Source: Bloomberg)
Finally, as long-term investors are looking to invest in companies that ride and survive cycles while improving their credit profiles, one cannot ignore the necessity to look at the way a company is addressing the sustainability challenge. The pandemic has rightly triggered an awakening in the necessity for urgent societal action. It is not about pretty corporate sustainability reports but about understanding the underlying shifts in consumer demands, the potential threats of the energy and social transition (with the increasing regulatory scrutiny) and how it will affect a business’ future competitiveness. Green, Social and sustainability-linked instruments make it possible to identify those companies that commit themselves to a strategic business transformation while giving us, investors, the tools to challenge them on their ambitions and pace of progress.
This commentary is intended for professional investors within the meaning of MiFID II. It is provided for informational and educational purposes only and is not intended to serve as a forecast, research product or investment advice and should not be construed as such. It may not constitute investment advice or an offer, invitation or recommendation to invest in particular investments or to adopt any investment strategy. Past performance is not indicative of future performance. The opinions expressed by La Française Group are based on current market conditions and are subject to change without notice. These opinions may differ from those of other investment professionals. Published by La Française AM Finance Services, head office located at 128 boulevard Raspail, 75006 Paris, France, a company regulated by the Autorité de Contrôle Prudentiel as an investment services provider, no. 18673 X, a subsidiary of La Française. La Française Asset Management was approved by the AMF under no. GP97076 on 1 July 1997.