A REVOLUTION, IN KEEPING WITH THE FIDUCIARY DUTY OF INVESTORS

Transcription

1 GREEN BONDS: A REVOLUTION, IN KEEPING WITH THE FIDUCIARY DUTY OF INVESTORS SRI News Autumn 2017 The asset manager for a changing world

2 SRI News - BNP Paribas Asset Management - Autumn 2017 SRI: sustainable and responsible investment BNP Paribas Asset Management is the source for all data as at the end of October 2017, unless otherwise specified. Please note that this document may contain technical language. For this reason, it is not recommended for readers without professional investment experience. CONTENTS 4 INTRODUCTION 5 WHAT KIND OF RETURNS CAN INVESTORS HOPE TO ACHIEVE FROM GREEN BONDS? 8 ARE GREEN BONDS REALLY GOOD FOR THE PLANET AND SOCIETY? 11 THE FUTURE OF THE GREEN BOND MARKET Publisher: Anthony Finan Editor in Chief: Andrew Craig Deputy Editor: Christine Bosso/Sandrine Bensussen Graphic design: AM STUDIO Photo credits: Shutterstock Printed on 100% recycled paper BNP Paribas Asset Management France, the investment management company, is a simplified joint stock company with its registered office at 1 boulevard Haussmann Paris, France, RCS Paris , registered with the Autorité des marchés financiers under number GP This material is issued and has been prepared by the investment management company. This material is produced for information purposes only and does not constitute: 1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Opinions included in this material constitute the judgement of the investment management company at the time specified and may be subject to change without notice. The investment management company is not obliged to update or alter the information or opinions contained within this material. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the financial instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for an investor s investment portfolio. Given the economic and market risks, there can be no assurance that the financial instrument(s) will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the financial instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to the financial instruments may have a significant effect on the results portrayed in this material. All information referred to in the present document is available on The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. 2 October Design : AM STUDIO - P

3 EDITORIAL The 23 rd United Nations Climate Change Conference will take place in Bonn this month. Although it will be held in Germany, the conference will be presided over by the Fiji Islands, to highlight the fact that small island nations are particularly exposed to the consequences of climate change. Such consequences include rising ocean levels and extreme weather events with dramatic consequences (such as those recently seen in the Caribbean and on the east coast of the United States, etc.). With the US president keen to pull out of the Paris Agreement signed at the COP21 summit, this Climate Change Conference will be an opportunity for the international community to gauge the progress that has been made and to insist on tangible action to honour the commitments made. While a considerable effort is still needed, a large number of initiatives have been undertaken to limit the rise in global temperatures by The German government has unveiled a new plan to develop renewable energies; Sweden has set a zero CO2 emissions target for as early as 2045; and China has stated its willingness to become one of the most committed nations in the fight against climate change. Expectations are also high in the financial sector. Article 173 of the French energy transition law made it mandatory for investors to disclose the manner in which they manage climaterelated risks. This initiative is sure to spread beyond France, as there is no doubt that the authorities in many other countries will introduce similar obligations. Gaëtan OBERT Global Head of Sustainability Environmental issues have been a core concern at BNP Paribas Asset Management for many years. We joined the Institutional Investor Group on Climate Change (IIGCC) in 2003 and have since played an active part in discussing the risks of climate change with investors, businesses and policy makers. Following on from the publication of our responsible investment policy in 2011, we published our climate strategy in 2016, declaring our ambition to contribute to a low-carbon economy in order to preserve economic stability and, hence, our clients longterm investments. Our commitment to promoting low-carbon solutions is one of the pillars of our climate strategy. We have developed a broad range of theme-based funds to invest in companies whose activities are synonymous with environmental issues. One particular financial instrument is a go-to investment to finance the energy transition: green bonds, which are the focus of this edition of our SRI news. Our experts explain why there is so much interest in this market. They then look at the inherent performance of green bonds, with a particular focus on measuring the impact of this type of investment. Lastly, they explain what decisions need to be taken and followed through to sustain the exponential growth that the market is enjoying today. Happy reading! Written on 2 November

4 SRI News - BNP Paribas Asset Management - Autumn 2017 INTRODUCTION ARNAUD GUILHEM LAMY, PORTFOLIO MANAGER FELIPE GORDILLO, SENIOR ESG 1 ANALYST We would like to thank Marion Castel and Théo Kotula for their contribution to this newsletter. Just four years ago, in 2013, the global issuance of green bonds barely totalled EUR 20 billion. By the end of January 2017, that total had surpassed the EUR 200 billion mark. And it is estimated that more than EUR 120 billion in new issues will have been made by the end of this year 2. This means that the market has increased ten-fold in that short time. That is exceptional growth for a product that can have lasting benefits for society and the planet. By way of comparison, the global impact-investing market represents around USD 114 billion in assets 3, with the first impact funds having emerged in the 1990s. Green bonds: cumulative issuance by year (EUR billion) Forecast - Sovereign Forecast - China Forecast - Sovereign, ex-china Achieved Source: Crédit Agricole CIB (September 2015) Even so, green bond issuance volumes are low considering the investment that is needed to finance the energy and ecological transition. According to the OECD 4, by 2035, the global economy will need a total green bond volume of USD 5.6 trillion and USD 720 billion in annual issuances to ensure that economic growth is aligned with a scenario in which the average increase in global temperatures is kept below 2 degrees Celsius. Potential for low-carbon bond issuance ranges between USD 620 billion and USD 720 billion per year by 2035 Bonds outstanding in the four regions Amount outstanding Issuance Source: OECD (November 2015) What is a green bond? EUR billion A green bond is a debt instrument that offers similar returns to regular bonds, the only difference being that the proceeds of green bond issues are used to finance a ssets a nd p rojects that are crucial to addressing environmental challenges such as climate change. There is nothing exotic about the green bond market: it involves the same types of active issuers as the fixed-income m arket, i.e. corporates, sovereigns, agencies, local governments and municipal authorities. It also uses the same types of investment vehicle: senior unsecured debt, asset-backed securities (ABS), residential mortgage-backed securities (RMBS) and covered bonds. In this newsletter, we take a look at the added value offered by green bonds. In doing so, we focus on two aspects: the financial returns that an investor can expect from a green bond and the benefits or positive repercussions for the planet and society Annual bond issuance in the four regions Written on 24 October ESG: selecting securities for investment on the basis of environmental, social and governance criteria 2 Crédit Agricole CIB. Green Bonds: feeling lost in the what is green? debate? Introducing our green bonds screener. July Organisation for Economic co-operation and Development - mobilising-bond-markets-for-a-low-carbon-transition en.htm 4

5 WHAT KIND OF RETURNS CAN INVESTORS HOPE TO ACHIEVE FROM GREEN BONDS? ARNAUD GUILHEM LAMY, PORTFOLIO MANAGER FELIPE GORDILLO, SENIOR ESG ANALYST Before we go any further, we should explain the notion of Green Premium, or Greenium. A green bond is said to be priced at a greenium when its price is higher than that of a conventional bond issued by the same issuer. In such cases, the green bond presents a tighter spread than the vanilla bond. Since both bonds are issued by the same entity, the anomaly in the pricing difference cannot be explained by credit quality differences. Rather, there are two types of explanation for this: ythe balance between supply and demand, which can take the form of: (i) a wide gap between inadequate supply and investor demand; (ii) growing demand linked to decarbonisation strategies and the increase of assets managed by funds specialising in green bonds. ytechnical reasons: (iii) the volume (or liquidity) of conventional bond issuance is greater than for green bonds; (iv) when the market adjusts the pricing of regular bonds depending on their exposure to transition risk. This is likely to occur as environmental regulation progresses. However, for the time being, there is no evidence of such a trend. So how do green bond prices behave on the market? To analyse price trends, we must first focus on (A) the primary market, where newly-issued bonds are sold by issuers or companies and bought by investors; and then (B) on the secondary market, also known as the aftermarket, where bonds issued on the primary market are then traded between investors. A) Focus on the primary market: are green bonds more expensive than regular bonds at issuance? According to a recent Climate Bonds Initiative (CBI) study 5, the growing demand for green bonds on the primary market is being driven by an increasing proportion of investors with decarbonisation objectives. For issuers, this should equate to more favourable pricing conditions at issuance. Oversubscription is the norm Number of times oversubscribed Source: Climate Bonds Initiative (Q4 2016) Final pricing is consistently tighter than initial price talk Basis points EIB EIB Muni Fin KFW KFW Tennet Société Générale Société Générale Tennet Rabobank Poland BNP Southern Power 19 BAML MTR Poland Southern Power 21 Southern Power 21 EDF BAML MTR Iberdrola Iberdrola Southern Power 19 Rabobank Bank of China -20 Swaps Treasuries Source: Climate Bonds Initiative (Q4 2016) 5 5

6 SRI News - BNP Paribas Asset Management - Autumn 2017 Green bonds are not more expensive than grey bonds. Felipe GORDILLO Senior ESG Analyst Of the 15 bonds analysed in the CBI sample, 11 presented a spread of more than five basis points between the initial price talk and the final pricing. The imbalance between supply and demand seems to be making it possible for some issuers to refinance at a lower cost than initially projected when they launched their green bond. The study therefore highlights the gap between the initial price talk and the final spread. However, this spread is not specific to green bonds and can also be seen with grey, or regular, bonds. Hence, the anomaly cited by the CBI cannot be applied indiscriminately to all green bonds. A recent study 6 across a sample of green bonds focused on the new issue premium (NIP), i.e. the additional spread paid on a new issue relative to existing spreads. The study found that the NIP on six green bonds was no lower than that paid on conventional bonds. There is therefore little evidence to suggest that green bonds are priced more tightly than regular bonds on the primary market. In a nutshell, green bonds are not more expensive than grey bonds. Besides, as the market expands and the supply and volume of issues grows, pricing anomalies on the primary market tend to vanish. What does this mean for investors? Since, upon issuance, spreads are no tighter on green bonds, investors do not have to sacrifice performance when they invest in a green bond. B) Focus on the secondary market: comparison between the spreads on green and non-green bond issuess Up until 2016, there was a consensus regarding spreads on the secondary market: while green bonds and regular bonds were not perfectly correlated, their differences in terms of spread were not significant. However, certain more recent studies maintain that the number of green bonds trading beneath the non-green curve is increasing. We sought to gauge this trend by comparing the secondary market spread on green bonds with that of conventional grey bonds. Our sample consisted of 18 pairs of green bonds and grey bonds, of comparable amounts and maturities, all issued by the same entity. In 12 of the 18 pairs, the green bonds were found to be trading at tighter spreads than the grey bonds. Green bonds traded at a wider spread than regular bonds in just four cases. And in certain of these four cases, the difference stemmed from redemptions of grey bonds, which made them more expensive. Z-spread for a sample of 18 green/grey bond pairs with equivalent maturities (in bp) Green bonds Grey bonds Years Source: BNP Paribas Asset Management (October 2017) Ibid 6

7 Arnaud Guilhem LAMY Portfolio Manager By investing in green bonds, investors can honour their fiduciary duties and still play a part in financing the energy transition. In the 12 cases in which green bonds were trading at tighter spreads, the average difference in spread for the sample was around three basis points. Our observations are in line with recent studies showing that green bonds perform well on the secondary market and even somewhat better than grey bonds 8. NIP New Issue Premium We also examined the yield curve on the secondary market for bonds issued by the European Investment Bank (EIB). The EIB is the most prolific issuer of green bonds, with five issues each exceeding EUR 1 billion. We can see from the following chart that green bonds are trading at tighter spreads than grey bonds on the secondary market. While still limited (in the range of three to five basis points), the difference is significant nonetheless. EIB bond yields Green bonds So, what does this mean for investors? By investing in green bonds, investors can honour their fiduciary duties and still play a part in financing the energy transition. To sum up, recent studies show that, on the primary market, green bonds are no more expensive than conventional bonds and that, when it comes to the secondary market, spreads on an increasing number of green bonds are evolving more favourably than those on non-green bonds. In other words, green bonds could be a source of value for bond portfolios. Written on 24 October /09/17 23/03/23 12/09/28 05/03/34 26/08/39 15/02/45 08/08/50 Source: BNP Paribas Asset Management (October 2017) 8 gordillo%40bnpparibas.com&token=zvuzxt7inhhxc7h1duytfqdjlceh8n 7

8 SRI News - BNP Paribas Asset Management - Autumn 2017 DO GREEN BONDS TRULY BENEFIT THE PLANET AND SOCIETY? FELIPE GORDILLO, SENIOR ESG ANALYST According to the definition used in the Green Bond Principles (GBP) 9, a green bond is any type of debt instrument where the proceeds are used to finance or refinance green projects. The GBP also require that the bonds be aligned with four core components: (i) use of proceeds; (ii) process for project evaluation and selection; (iii) management of proceeds; and (iv) reporting. To evaluate the environmental and social benefits of green bonds, close attention must be paid to components (i) and (iv). This means that it is important to look at the type of projects selected and financed by the proceeds, as well as their outcome and impact. A green bond has a beneficial impact if the proceeds are invested in promising projects and if, once such projects have been implemented, they involve a comprehensive and robust reporting mechanism. With this in mind, BNP Paribas Asset Management has developed an engagement process specific to green bonds, with the aim of avoiding any reputational risk associated with project implementation. Accordingly, bonds are analysed at issuance on the primary market and projects are evaluated based on their compliance with a list of eligible sectors and projects drawn up by BNP Paribas Asset Management. Additionally, issuer reports on the green bonds are closely scrutinised to gauge the outcome and impact of projects. Throughout the engagement process, the team of analysts at BNP Paribas Asset Management s Sustainability Centre is constantly at work to consult with and challenge issuers on the implementation of their green bond programmes. Green bonds engagement process Engagement process at predeal and regular meetings At the time of issuance EX ANTE 1 yearafter issuance EX POST Green bonds engagement process 1 st filter 2 nd filter 3 rd filter 4 th filter 5 th filter ESG decile: assessment of the issuer s ESG credentials. Decile 10 are OUT. Taxonomy: the projects to be funded must be in line with our definition of eligible activities. If the issuer plans to finance excluded activities e.g. large hydro*, nuclear*, fossil fuels*), the recommendation is OUT. Green bonds implementation: (1) disclose a forecast of their green projects allocations; (2) manage the potential environmental and social risks embedded in this project; (3) clear governance structure for the project selection and evaluation. Ex post reporting: if the issuer doesn t provide reporting, the recommendation is OUT. Engagement with the issuer: consultation on the actual proceeds allocation, outcome indicators and impact indicators. If engagement is satisfactory, the recommendation is IN for another year. If not, it is OUT. *According to the Climate Bonds Initiative and the Transition Energétique et Ecologique pour le Climat Label (TEEC) Source: Sustainability Centre - BNP Paribas Asset Management Use of proceeds In their ex ante analysis, the analysts verify that the bond is in line with the taxonomy 10 of the eligible sectors and projects defined by BNP Paribas Asset Management. This list currently includes the following sectors: renewable energy, energy efficiency, green buildings, transport, waste management, water management, natural resources and social initiatives. A certain number of criteria and standards are applied to each sector of the taxonomy to determine whether the financed assets are compatible with the development of long-term solutions. When projects are intended to tackle climate change, the analysts only include assets that are in line with a scenario in which global warming is kept below 2 degrees Celsius. According to the International Energy Agency (IEA), for such a scenario to be possible, more investment must be made in biofuels and initiatives to increase the energy efficiency of the industry, building and transport sectors, as well as in renewable energies. 9 GreenBondsBrochure-JUNE2017.pdf 10 BNP Paribas Asset Management. Green Bonds Handbook. Eligible technologies taxonomy. February

9 A green bond has a beneficial impact if the proceeds are invested in promising projects involving a comprehensive and robust reporting mechanism. Felipe GORDILLO Senior ESG Analyst At the same time, the volume of additional investment in the gas, oil and coal industries must be lowered. BNP Paribas Asset Management has therefore decided to exclude assets or projects related to fossil fuels from its green bond investment scope. Furthermore, although in some cases assets in the fossil energy industry can allow for a sizeable reduction in greenhouse gas emissions over the near term, the company is committed to supporting green bonds that are compatible with long-term climate scenarios 11. Additional investment needs under the IEA 2 C scenario (vs. base case), globally and by category -50% 0% 50% 100% 150% 200% Biofuels EE - Energy-intensive industry EE - Non-energy-intensive industry EE - Buildings EE - Transport Nuclear Renewables Coal power Gas power Gas Oil Coal Source: IEA, Crédit Agricole CIB (November 2016) Meanwhile, to avoid any controversy or an increase in reputational risk, the ex ante analysis also assesses how the environmental and social risks associated with the financed projects are managed. Issuers are asked to explain the procedures that must be followed should a project have an adverse or unexpected impact, to clearly define the governance structure responsible for mitigating any undesirable repercussions and to describe the standards and frameworks used in this mechanism. A green bond is beneficial to the environment and to society if any unexpected or undesirable impacts related to the implementation of a project have been clearly mitigated and offset by the issuer, and if the positive repercussions are consistent with a sustainable, long-term development vision. In 2015, the United Nations brought into force a series of Sustainable Development Goals (SDGs). Governments and businesses can use these SDGs 12 to measure their actions and contributions to the welfare and protection of the planet. At BNP Paribas Asset Management, we have decided to incorporate green bonds into our investment universe precisely because they are an effective vehicle to advance the sustainable development agenda. % of bonds contributing to the Sustainable Development Goals (SDGs) 70% 60% 50% 40% 30% 20% 10% 0% 61% SDG 7 Clean Energy SDG 11 Cities 15% 13% SDG 13 Climate 5% SDG 9 Infrastructure SDG 4 Education 3% 2% 1% 1% SDG 10 Inequalities SDG 1 Poverty Source: Sustainability Centre - BNP Paribas Asset Management (October 2017) SDG 6 Water

10 SRI News - BNP Paribas Asset Management - Autumn 2017 Most of the proceeds of green bond issues go towards financing SDG 7 Affordable and Clean Energy, with 67% of the bonds supporting this goal. The second most funded category 15% of the bonds corresponds to SDG 11 Sustainable Cities and Communities. The bonds within our investment scope also support, albeit to a lesser degree, more socially-oriented goals, such as education and the fight against poverty. Impact reports Why is it important to ask issuers to provide impact reports? Because it is a way for investors to quantify and measure the positive repercussions of their investments, and it enables them to verify that the issuers responsible for the implementation of projects are delivering on the promises made at issuance on the primary market. In their ex post assessment, the analysts examine the quality and transparency of the issuer s disclosures. For this, they monitor how funds are allocated to environmental or social projects and examine information on the positive repercussions, in the form of outcome or impact indicators. Reports by issuer category 25% 20% 15% 10% 5% 0% outcome indicators not provided impact indicators missing ,5 Bank Corporate SSA* All sectors * Sovereign, Supranational and Agencies Source: Sustainability Centre - BNP Paribas Asset Management (October 2017) 20,7 We have noted a steady increase in the number of impact reports. A report is issued for 95% of the bonds included in the scope of our coverage 13. However, there are still some disparities in the content of these reports, with 21.5% of them not supplying any information on the outcome of the projects. For instance, in the case of some renewable energy projects, the issuer does not disclose the outcome indicator installed capacity in megawatts per hour. Furthermore, impact indicators measuring the benefits for society and the environment are missing in 20.7% of the reports on green bonds. It is also worth mentioning the degree to which impact reports use external verification or audit. Despite this now being standard practice in the sector, 72% of the impact reports published contain no third-party checks. Very little content is comparable from one impact report to the next, and this is currently one of the major challenges in the green bond market. Within a given business sector, issuers can apply very different indicators, frequencies and scopes in their environmental impact reports, for example. We believe that harmonised reporting methodologies are needed to ensure the integrity of these reports and thus the confidence of existing and prospective investors. Indeed, development banks have recently proposed a common framework for impact reporting on renewable energy projects 14. Issuers could also build on existing standards that have been in place for years to report on companies ecological footprint 15. The market has been undergoing constant change in the past 10 years. Just a few years ago, the simple issuance of a green bond was deemed praiseworthy enough, and the publication of an impact report was considered unnecessary. Now, it is the norm for issuers to provide evidence of the benefits of projects in the form of a report. As we move forward, we are hopeful that the information disclosed in these reports will be sufficiently transparent and standardised to enable comparisons between bonds, as is already the case in other sectors (for instance, in the food industry, where consumers can easily compare the calorific, protein and sugar content of any product). Written on 24 October The scope of our coverage corresponds to green bonds included in the Bloomberg Barclays MSCI Global Green Bond Index and bonds issued outside the index. This is not the same as our investible universe, which is made up of bonds that are eligible in accordance with our analysis methodology

11 THE FUTURE OF THE GREEN BOND MARKET HELENA VINES FIESTAS, HEAD OF ESG RESEARCH FELIPE GORDILLO, SENIOR ESG ANALYST Although the market in green bonds is still far from mature, encouraging trends are emerging that show the added value and relevance of these instruments. Investors are now in a position to honour their fiduciary duties while addressing the challenges facing our planet and humanity today. Felipe GORDILLO Senior ESG Analyst Helena Vines Fiestas Head of ESG Research In Europe, institutions are also seeing the benefits of such investments. The work on sustainable finance carried out by a High-Level Expert Group (HLEG) 16, and coordinated by the European Commission, found green bonds to be an effective tool in financing solutions to environmental challenges. The members of the HLEG have notably proposed two measures which they believe could boost growth and enable the sector to achieve market scale in Europe. The first measure involves introducing a European standard built around existing eligible sector taxonomies, along the lines of those developed by the Green Bond Principles. The second calls for the development of a European label to promote transparency and provide a guarantee to investors of the environmental and social quality of bonds that are issued. These measures are fundamentally important, both to standardise the sector and enable it to achieve market scale. We also have some of our own recommendations: 1. The taxonomy of eligible sectors should build on existing initiatives. When it comes to climate change, we believe it is important to verify that technologies are commensurate with 2º C scenarios. 2. Standardisation must include a reporting protocol on the benefits for the environment and society. Better reporting transparency would make it possible to compare and classify green bonds according to their respective impacts. 3. The labelling process needs to be dynamic to rapidly reflect innovations in the market. Past experience has shown that an overly-prescriptive label that slows the market may be a disincentive and exclude more advanced products and technologies. 2 C is the objective set at COP21 aimed at limiting global warming 4. The labelling scope must also include green bond investment funds, as market transparency is essential, in our opinion. To ensure this, fund managers must be rewarded when they use sustainable, responsible best investment practices. Written on 24 October

12 IN A CHANGING WORLD, YOU NEED TO KEEP AN EYE ON THE RIGHT PATH. At BNP Paribas Asset Management, we manage assets with the world in mind, looking beyond financial metrics to ensure we manage all risks and invest in responsible businesses that perform over the long term. This is why we say: investing means the world to us. The asset manager for a changing world This advertisement is issued by BNP PARIBAS ASSET MANAGEMENT Holding, a Public Limited Company with its registered office at 1, boulevard Haussmann, Paris, France, RCS Paris BNP PARIBAS ASSET MANAGEMENT Holding comprises a number of entities. For further information, please visit