Climate Bonds: the Devil is in the Details… and in the Price

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    NordSIP (Stockholm) – On January 31, Danske Bank and Climate Bonds Initiative invited NordSIP alongside more than 50 investment professionals to sit around breakfast and discuss challenges surrounding the green bond market. Manuel Adamini (pictured right), Head of Investor Engagement at the Climate Bonds Initiative (CBI) presented his organisation’s taxonomy and led the ensuing discussion. While most intervening participants celebrate last year’s successful development of the SEK green bond market, the main challenges reside in details around green definitions and climate relevance, as well as the still elusive ‘greenium’.

    In an eloquent introduction, Adamini reminds us of the urgency of counteracting climate change. “If we don’t take action, the collapse of our civilisation is on the horizon!” he says, quoting Sir David Attenborough. “We have already shown that we can achieve progress at a tremendous speed, now what we need is scale.” Capital should be harnessed and redirected to drive change faster. In a market like Sweden, where green bonds represented more than 10% of all bond issues in 2018, climate finance can no longer be ignored. Adamini hopes that such progress will inspire other markets and in particular his homeland, Germany, where adoption has been somewhat cautious so far.

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    One of the often-cited shortcomings of climate finance is the lack of uniformity and reliability of existing standards. To palliate this issue, the CBI proposes a taxonomy ahead of the EU Commission’s upcoming effort to establish its own taxonomy, thereby lending credibility and legitimacy to green bonds among other climate financing solutions. As Adamini points out, the CBI taxonomy exists in both English and Chinese. In a centrally-planned economy such as China, the popularity of climate finance is highly encouraging.

    While distinguishing between different shades of green may be highly technical and daunting to the neophyte, the CBI proposes an easy entrance door. “What assets do I have on my balance sheet? How climate-relevant are they? The taxonomy can help you make this assessment. When it comes to the fine lines, some pieces may still be missing, but we help you make a quick choice between what is definitely a good project (green) and what is not (red). In between (yellow), the project may be green, but it needs to qualify for specific thresholds.”

    For example, real estate is a sector where misguided thresholds may prevent progress from being achieved in the right places, argues Björn Bergstrand, Head of sustainability at Kommuninvest, a financing cooperative for Swedish municipalities. The Technical Expert Group (TEG) appointed by the EU Commission to work on a green bond taxonomy among other frameworks to facilitate sustainable investing, currently proposes that to qualify for green financing, projects involving retrofitting of existing buildings should achieve at least 50% emission reduction. According to Bergstrand, however, the Center for International Climate Research (CICERO), an organisation known for its independent second opinions on green bonds, estimates that two-thirds of all green bond issuers wouldn’t be able to comply with the new European taxonomy.

    “This discussion is crucial for us,” says Bergstrand. “There are different ways of viewing energy efficiency, and it will influence the prioritisation of projects. Newbuilds will show more operational emission efficiency, but when you take life-cycle emissions and the construction process into account, then the retrofitting of existing buildings appears a lot more attractive. We need to stimulate efficiency gains as much as possible, instead of limiting green financing to those projects where the gains are the highest. It is imperative that the EU Sustainable Action Plan becomes inclusive and a strong tool of engagement, also in countries which are relatively advanced in terms of energy performance of the existing building stock.” Bergstrand encourages investors to send feedback related to this particular aspect of the TEG’s proposal, which is currently open for comments.

    For Johan Fredriksson, portfolio manager at Swedish real estate company and recurring green bond issuer Vasakronan, agrees. “We have already achieved a high level of energy efficiency,” he says. “Our buildings have a lower energy consumption than the average, by far. The more energy efficient you are, the tougher it becomes to achieve further efficiencies. We still see great opportunities in energy-saving retrofits. The production of concrete used in the construction process has a high footprint that mustn’t be ignored. Improving the existing stock is always preferable to building new real estate, from an emissions perspective. Also, in our experience the efficiency gains do not necessarily exhibit a linear relation with capital spent. You may improve by two notches on our local efficiency scale, which corresponds to approximately 30%, and that will be rather easy to achieve and therefore capital efficient. Beyond a certain level, however, energy efficiency gains can be very costly.” Against this backdrop, Bergstrand asks the following question: “Should we focus on achieving very high gains with only a small number of targets, or should we spread out and make sure a large number of targets achieve less ambitious energy gains?”

    While the taxonomy, particularly at the European level, may still have room for finetuning, Adamini demonstrates how climate financing can help progress in very different sectors, from forestry, agriculture and fisheries to hydropower and other renewable energy sources. When building a suitable system that can be used to direct capital worldwide, a one-size-fits-all taxonomy cannot satisfy the diversity of climates and business ecosystems. On the other hand, investors are craving guidelines to lend legitimacy to a burgeoning fixed income market.

    Finally, the question of greenium surfaces in the discussion when Marcus Widegren, Director of Institutional Sales at the alternative mortgage provider Enkla, points out that, while he is a passionate believer in climate finance and is keen to contribute, finding the financial incentive to do so is only part of the important equation. The most fervent defender of green bonds so far, one of the participants representing the Region of Stockholm argues that her entity’s latest issue wouldn’t have gathered so much capital if it hadn’t been green. The issue also achieved a 2-3 bps greenium. For another company present, on the other hand, the ambition of issuing green bonds stopped at the CFO’s office, where the additional reporting cost became an insurmountable hurdle.

    For Adamini, the main benefit of climate finance to corporates is its signaling function. Typically for large triple-A rated entities, issuing green may be of limited immediate advantage. Such firms do generally already enjoy excellent access to capital, may find it hard to achieve a price advantage, and would thus have to be satisfied with increased investor diversification and internal and external reputational wins. However, in high yield territory, for instance, or for less mainstream issuers, green finance may be the way to attract investors that would otherwise not have looked at a particular investment opportunity at all. Vasakronan’s Fredriksson concurs: “I am going around Europe and talking to investors I would never have talked to if it weren’t for the fact that we are issuing green bonds,” he says. “It may be difficult to evaluate the value of the greenium, but there are growing pools of dedicated green capital in Europe, and it will make a difference eventually.”

    Picture © NordSIP – Manuel Adamini (right), Lars Mac Key, Danske Bank (left)

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