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Make America Green Again

Sustainable Finance January 15, 2021
Sustainable Finance January 15, 2021
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As the world looks toward a new administration in the United States, BMO Capital Markets Fixed Income Strategy Director, Dan Krieter, looks at the potential for growth in the issuance of, and investment in, green, social and sustainability bonds. In the run-up to the new presidency, Dan, who focuses on sustainable fixed income investments and leads the Group’s research in the green bond space, penned a recent report, Make America Green Again.

Following is a conversation with Dan, edited for length, on the main findings of the report, and the likely future of U.S. sustainability debt issuance.

Q: You recently issued a report titled “Make America Green Again”. What are the key takeaways from the report, and why the title?

Why the title? Basically, I just wanted to draw an explicit link and underscore how important the relationship is between the presidential administration and the incorporation of sustainability initiatives into the financial system. And what the report was really trying to do was to highlight how President-elect Biden seems to be making it an objective of his administration to increase environmental consideration. During his campaign, he was running on a platform of infrastructure spending of $2 trillion and there’s a large green component of that. Now, even if that construction plan doesn’t come to pass, it shows that sustainability is at the top of Mr. Biden’s platform.

As well, since the election, we’ve seen Janet Yellen be named Treasury Secretary and she is a staunch supporter of environmental issues and has already started to talk about some of the measures she wants to take. And even away from the election, the Federal Reserve has recently started taking a much stronger interest in taking climate change factors into account in their role as bank regulators in the U.S. There’s been increasing chatter for environmental stress tests for banks that has already resulted in a letter from congressmen to the FED to talk about where the FED is with these efforts.

Q: And that is as a risk mitigation measure?

Yes, in their role as bank regulator to the financial system and amid an increasing sense that, not only does environmental risk pose a threat to the world but poses a threat to insurance companies and major players in the financial system, as climate change results in more natural disasters and the financial system is left exposed.

Q: What are the most important drivers you see for increased sustainable debt issuance?

Green infrastructure. It’s really a change in the new administration’s attitude, because what it comes down to is investment options. In sustainable investing, there is the fear of “green washing”, and the government must get involved at some point to try to help solve those problems. There are international organizations like ICMA that have made tremendous progress, but if you also look at other jurisdictions like Europe, other places like Canada and China, a lot of them have their own government sustainable investing frameworks that guide the investment process in the individual jurisdictions, which currently doesn’t exist in the U.S.

With a new administration in charge, and with the experiences of the rest of the world to show the way, it might help the U.S. drive toward more sustainable investment in the corporate sector; if companies have to start disclosing exposure to environmental issues, and investment dollars flow to corporations that perform best, it could become a driving force behind change in attitude from the top down.

As it stands today, if you look at the share of debt issuance in the world, the U.S. comprises about 40 percent of that, but the U.S. share of sustainable debt is only about 15 percent.

Q: You have seen an explosion in the social/sustainability debt market. Is that in terms of demand? To what do you attribute this, and do you see it continuing?

I think it is partly demand, but I also think another reason for the explosion in sustainability debt lies in the desire on the part of companies and corporations around the world to issue in the sustainable debt market, but who may lack the types of projects that would traditionally see them issue green bonds.

The sustainable debt market as a whole started with Green Bonds about 10 years ago, but Green Bonds are those specifically focused on projects that have environmental outcomes, so, for example trying to avoid greenhouse gas emissions and the like. Well, not all companies have a project that is going to be considered as having an environmental outcome. Green bonds tend to be mostly, but not exclusively, for government-led projects like electricity grids or transportation infrastructure, which is mostly done at the governmental level, or quasi-governmental level, with some exceptions, like solar panel projects and the like.

With social and sustainable bonds, the definition of what you can use those proceeds for is much broader. It’s more applicable to corporates, where the bond is not going to have an environmental impact, but it will have a human impact and a social impact.

Q: How does COVID-19 weigh into the equation?

I think more and more we are seeing a shift in sustainable bonds to investment along the Sustainable Development Goals as expressed by the UN, and one of those is health. Obviously, COVID-19 underscored the threat to health under this pandemic and how we have to change our infrastructure to really achieve better results and better impacts from a health perspective. COVID-19 has resulted in a massive response from governments around the world to avoid some of the worst possible economic and health impacts of the pandemic. We’ve seen pandemic-response bonds, we’ve seen governmental borrowers, needing more funding to invest in PPE and things of that nature. All of these projects can be seen as sustainable and used for social or sustainability bonds. The pandemic resulted not only in greater recognition, but also a greater response in the market as governments try to fight the pandemic.

Q: Are we entering a new era in big deals in sustainable debt issuance? What will drive that? What could derail it?

I think we are entering into a new era of bigger deals in sustainable debt issuance, and that’s really a lot to do with the engagement in the market on the governmental level. Some of the leading borrowers in the world, for example Germany, issued their first green bond this year. Governments are increasingly turning to sustainable debt markets to fund programs … The EU, having issued zero green bonds prior to 2020, will become the largest ESG borrower in the market in the next few years, so you are just seeing greater governmental issuance around the world. The government bond market is the largest bond market in the world by a lot; governments typically lend themselves best to environmental and sustainable objectives, whether it’s helping the poor or sustainable infrastructure and things of that nature. It’s really important that governments continue to engage the market now, and in the years ahead. Maybe not in the next year or two, but it wouldn’t be impossible to see a green bond from the (U.S.) Treasury maybe five years from now.

Q: And why would that be important?

It’s like what we see happening in France or in Germany. France and Germany are two of the other largest bond issuers in the world, behind the U.S., and they’ve just carved out a certain portion of their issuance that is going to be considered green, sort of like how the U.S. government now issues a slice of its debt profile that is inflation protected. It’s a smaller portion of the debt borrower program, but it’s there and you can see how they might carve out for green treasuries some day. Maybe not in the next year or two years for sure, but maybe four or five years from now, that could be something the Treasury does. You’ve seen Treasury innovate even in the last couple of years. Treasury monitors financial markets and they evolve their product following to be in line with trends, so as demand builds (for sustainable bonds) here, Treasury could certainly adapt issuance in line with that trend.

Q: Can you describe and discuss the concept of a “Greenium”, how it applies to Sustainable Debt Issuance and why it’s important?

When we say “Greenium,” we are referring basically to higher prices for sustainable investing, and in the bond market what that means is lower yield. So, if you have, say, a five-year bond at 1 percent, if there is a “Greenium,” an investor would pay a higher price for a similar security with sustainable characteristics. This means the investor earns lower return, say 0.95 percent. That 0.05 percent or five basis points increase would be the Greenium.

It’s a crucially important topic in sustainable finance because it really is the incentive for borrowers of money to look to the sustainable market. Issuing in the sustainable market does come with more cost. Due to the fears of green washing, there has to be more structure around it: you have to pay for an auditor to come and audit the issue, and assure investors that you are following sustainable protocols; and you have to hire environmental experts to monitor projects and report back to investors. So, there is an actual increased monetary cost to issue sustainable debt and that has to be offset by savings in the capital markets. Otherwise, why would you do it? If investors are truly trying to help change the world with their sustainable investments, they are going to have to be able to accept lower financial returns in exchange for a better sustainable return or environmental return.

Q: What has your research into Greeniums shown?

Because it’s such an important topic, I’ve done a study of trends every year over the past five years in various currency markets, and what’s notable is that in 2020 for the first time, we did see significant and observable evidence of a Greenium in the Euro markets. It’s not a surprise that the Euro is first as Europe is at the forefront of all the sustainable financial markets, but it goes to show that, for this to work, there needs to be sufficient support to have sustainable investments trading sustainably and durably at higher prices. There is no Greenium in the U.S. yet, but some day there will be, and what that means is if you are one of the first buyers of sustainable assets, then you have the opportunity to see your price appreciate more than others. I think the existence of a Greenium around the world will only work to increase interest in sustainable debt markets here in the U.S., how to build demand and how to build markets, so it’s a very, very crucial topic.

Green Finance has been a reoccurring topic on our Sustainability Leaders podcast. You might enjoy these episodes:

Dan Krieter co-hosts a weekly High Quality Credit Spreads show on Macro Horizons podcast. 

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Dan Krieter, CFA Director, Fixed Income Strategy

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