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How green are green gilts?

3 Feb 2021

In November, Rishi Sunak announced his plans to issue green gilts, an initiative warmly received by institutional investors. But how sustainable these bonds likely to be?

At the end of last year, Chancellor of the Exchequer Rishi Sunak announced that the government will issue green gilts for the first time in 2021, an initiative long awaited by many institutional investors. So far, Sunak has disclosed little information about volume or timing of the issuance, apart from a pledge that the proceeds will help the UK “become a world leader in green finance”.

He said the launch of the debt was “subject to market conditions” and would be the first in a series of issuances aimed at financing projects to tackle climate change and broader infrastructure investments. The announcement came as the UK is preparing to host the COP26 conference in Glasgow in November and could play an important role in the UK’s ambition to become carbon neutral by 2050.

Late to the party

But the UK has come late to the green bonds party. Germany, Poland, the Netherlands, France and Ireland issued green sovereign bonds last year. France, for example, was among the first countries to do so back in 2017 and has so far raised more than €25bn (£22.1bn) with plans to raise more.

Meanwhile, Germany has issued green debt through KfW, its state-owned infrastructure investment bank, and directly in its bunds, the first of which were issued in September and saw more than €33bn (£29.1bn) bids for what was initially a €6bn (£5.3bn) deal over 10 years. The bonds were priced at a yield of -0.463% with investors paying a premium of 1bsp compared to conventional 10-year bund yields.

This raises the question whether Germany, which already has historically low borrowing costs, needs the green bond label to finance infrastructure investments. The German finance ministry has highlighted how its previous budget includes €12.7bn (£11.2bn) in green investments to match the total sum it intends to raise through green bonds. However, the government has not committed to use the proceeds of the green bond issuance directly for these projects and the investments might have taken place anyway.

As such, the green bunds fall short of the green bond principles set out by the International Capital Markets Association (ICMA), which is the most popular framework for assessing the validity of green debt. The ICMA’s definition states that proceeds must be exclusively applied to finance or re-finance green projects.

The UK’s proposed move into this market has been warmly welcomed by investors. Investors have been pushing for this for some time. Indeed, a month before the announcement, a coalition managing more than £10trn of assets between them, including Brunel Pension Partnership, Nest and Coal Pension Trustees, urged the government to embrace green gilts.

Late to the party

Similarly, Rishi Sunak’s latest spending review, published a week after the green gilts pledge, provided little insight as to how the proceeds would be allocated. Of the £100bn the chancellor plans to invest in infrastructure, only 1% has been earmarked for making buildings more energy efficient. Real estate is a huge contributor to climate change and therefore reducing its CO₂ emissions is crucial to transiting to a carbon neutral future. Meanwhile, road building schemes account for almost a third of the infrastructure budget, despite increasing the level of CO₂ emissions.

The challenge for investors wanting to invest in these gilts will be to establish whether they will make the UK economy greener or if they will be a victim of greenwashing. Much like buying green energy from a conventional electricity company does not mean that the household in question will be supplied with energy from renewable sources, the purchase of a green bond could have little connection to actual investments in renewable energy.

Sir Robert Stheeman, head of the UK Debt Management Office, warned investors at the beginning of last year that any proceeds from green bonds would be largely symbolic. As in the case of the German issuances, the money would flow back into central government’s accounts. Whether the green gilts issued by the UK remain largely symbolic or not depends on the criteria that the government chooses to comply with. Rishi Sunak has already pledged to establish a new green taxonomy, which would be similar to the one used by the EU.

However, another step forward could be the introduction of clear ringfencing rules for the use of proceeds of any bond labelled green. This, however, could mean investors having to commit to paying a premium for the cause.

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