Cover Story: Stimulating growth in green markets

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on January 6, 2020 - January 12, 2020.

As a committed player, we believe we need to go further and play a role in stimulating green market growth. In this regard, Amundi has been involved in several initiatives in partnership with major financial institutions.

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Green financing and investments are developing into the next big story for the coming decade, if the fact that 2019 was a record year for the green bond market is an indication of things to come. As at end-October, the total value of green bonds issued was more than US$680 billion (RM2.81 trillion). The primary market hit a new record with more than US$220 billion, according to the Climate Bond Initiative (CBI).

Beyond the supportive underlying market environment and the rebound in green funding from agencies (which had slowed down in 2018), the traction of green bonds proved particularly strong in terms of new issuances, outstanding amounts and number of issuers. This was illustrated the significant rise in the number of debut issuers, which stood at more than 215 as at end-2019, and the strong contribution from new sectors.

The world needs to intensify its efforts to combat climate change meeting the goal of the 2015 Paris Agreement to limit global temperature increases to 1.5°C. Given the magnitude of the needs (over US$53 trillion 2035), new sources of financing are required.

Green bonds are a vector of choice to fulfil this goal and their potential continues to increase. More broadly, combating environmental risk has sparked a recent growth in new and innovative financial solutions to support the global transition to a low-carbon economy, which should benefit us all in the long term.


Broader set of opportunities available to investors

The green bond market is becoming more diversified, with a more balanced issuer profile in terms of issuer types. In 2019, corporates were leading the way, with 22% from the financial sector and 20% from the non-financial sector. Sovereign issuances kept the momentum going at 22%, with the Netherlands in the lead and Chile, South Korea and Hong Kong with inaugural issuances.

Sovereign issuances should continue their strong and sustained growth in 2020 as nine countries have already expressed their willingness to issue green bonds. In the corporate space, we now see the financial sector taking back the lead in terms of new issuances, owing to more stable funding, potential to expand eligible assets (for example, residential green buildings and sustainability bonds) and new contribution from the insurance sector.

In 2018, most issuers from the corporate (non-financial) segment were utility companies, which have the highest needs in terms of financing the energy transition. In 2019, we saw many debut issuers from sectors such as telecommunications, F&B and automobile companies.

The steady development of the green bond market creates new opportunities for both investors and issuers. Green bonds enable issuers to:

Enhance their reputation and develop corporate branding.

Attract new investors and diversify their investor base. It is proven that when companies issue a green bond, they usually double their investor base attracting “responsible investors” — green bond thematic funds or committed investors such as European pension funds and insurance companies — who would not otherwise invest in their regular bonds. In addition, green bonds issuance usually display an oversubscription ratio of three to four times.

Find financing during less favourable market conditions. For example, in November and December 2018, the European Corporate Credit primary market dried up owing to investors’ concerns over a further slowing down in the pace of European growth and political uncertainties. However, the green bond primary market was much more resilient.

As for investors, green bonds are a solution to:

Fulfil their fiduciary duties, regulatory obligations or non-financial reporting requirements;

Direct financial flows to specific projects that support projects that contribute to sustainable development and assets earmarked as green; and Meet a certain number of environmental criteria.

Investors are increasingly worried about global warming and its impact on the sustainability of their investments. In this context, green bonds are financial products that are dedicated to financing environmental projects such as renewable energy, energy efficiency, green buildings, clean water or pollution prevention.

Their special feature is issuers’ transparency, via the reporting on the use of proceeds. It is worth noting that transparency does not impact the financial risk of the bond. Green bonds are pari passu with other bonds of the same issuer with the same seniority. The financial risk of a green bond is related to the credit quality of the issuer and has no direct link to the green project itself.

While this is fundamentally positive, as valuations are left to market forces, green bonds’ valuation may take into account strong demand from investors and regulators’ willingness to direct flows into energy transition instruments. This said, at the moment, there is no clear evidence of a significant negative premium (for the investor) in every fixed-income category of the market, compared with other regular bonds. Consequently, as an investor, we believe green bonds should not trade significantly tighter as they share a similar credit-risk profile as plain-vanilla bonds.

Asset managers invest in green bonds to build up their environmental offerings. They can range from pure strategies with an impact objective in terms of carbon dioxide emissions avoided to strategies that aim to finance the energy transition.


Impact reporting becoming a standard

A few years ago, only around 60% of issuers were measuring their impact but today, most of new issuances do that. At Amundi, we have launched an Impact Green Bond strategy in 2016, with the strong conviction that impact should be fully integrated into the investment process to deliver both impact and financial returns.

In addition, green bonds create market-driven demand for improved environmental, social and governance (ESG) disclosure companies and financial institutions. This will have a tangible knock-on benefit in facilitating sustainable finance across a range of asset classes and financial products. It also enhances the ability of regulators to assess ESG risks and green finance flows at market level, enabling them to structure regulation and incentives to drive more capital to sectors with high environmental and social benefits.

As a committed player, we believe we need to go further and play a role in stimulating green market growth. In this regard, Amundi has been involved in several initiatives in partnership with major financial institutions.

For example, in 2018, Amundi partnered with the International Finance Corp (IFC), a subsidiary of the Word Bank, to bridge the gap between institutional investor capital from developed markets and financing needs for climate-smart projects in emerging markets (EMs). IFC raised US$1.4 billion through a closed-end fund with the aim of enhancing the supply of green bonds issued financial institutions in EMs. In a seven-year investment period, the fund intends to transition to a 100% green bond portfolio and allow investors to access climate-smart investment opportunities to support the global transition to a low-carbon economy and fight climate change in EMs bolstering both supply and demand of green bonds.


Role of regulation in green investing

One of the key success factors for green finance to become perennial in the long run is international standardisation of transparency and simplicity. International consensus is emerging when it comes to the best practices in the issuance of green bonds. Most frameworks for green bond issuance align with the Green Bond Principles (GBPs), hosted the International Capital Market Association (ICMA), and/or the Climate Bonds Standard and Certification, offered the non-profit, CBI.

These best practices help align definitions in a broad universe. Green taxonomy is a unified classification system and an important resource for common green definitions across global markets. It is expected to encourage investments in sustainable finance providing certainty for investors as to what is classified as “green”. Green taxonomies typically include renewable energy, energy efficiency, adaptation to climate change, waste management, pollution prevention, water management, biodiversity and ecosystem protection, sustainable transport, sustainable agriculture and green buildings. Green issuers are increasingly complying with the GBPs set the ICMA. This is gradually turning green bonds into a standardised and homogenous asset.

On June 18, 2019, the European Commission released a proposal for an European Union Green Bond Standard. This standard consists of voluntary guidelines, built on current best market practices. The EU Green Bond Standard goes beyond the GBPs, as additional requirements involve the following:

The proceeds will not only finance projects that contribute to an environmental objective (according to the new EU taxonomy) but also will not harm the other environmental objectives and will respect minimum social requirements;

Mandatory reporting on not only the use of proceeds but also environmental impact; and Mandatory external review of the green bond framework.

We believe this new standard should bring more confidence to investors and reassure them in terms of mitigating green-washing risk. It should help to further develop the green bond market incentivising both issuers and investors. However, we need to carefully monitor how it is implemented to make sure that it will not be too stringent, which could hinder issuers.

Since traditional financial instruments are usually in the form of senior debt with recourse to the balance sheet of the issuer, green bonds fit appropriately into investors’ traditional fixed-income allocations. They provide institutional investors with relatively long-term maturities, in line with their liabilities, and relatively stable and predictable returns for their given risk exposure.


Beyond green investing

As a responsible investor, we believe the environmental theme should be a long-term play. At Amundi, the social theme is also key and should be further developed.

We intend to foster the development of this new fast-growing market through innovative initiatives encouraging more issuers.

More broadly, we are convinced that ESG factors form the backbone of all investment decisions. Amundi has been a pioneer in considering ESG issues in investment management. The group launched its first socially responsible investment fund in 1989 and has developed its proprietary rating system for over 10 years.  

Vincent Mortier is the group deputy chief investment officer at Amundi Asset Management