Many governments and local authorities already fund projects that could fit socially responsible investors’ investment criteria, but very few have printed specially themed bonds with proceeds going to fund environmental, social and governance improvements. If they were to do so, they could access a fast growing pool of liquidity.
“Many of the assets that sovereign and sovereign agencies have on balance sheet are climate friendly assets and could be backed by green bonds,” says Philip Brown, head of public sector debt origination at Citi in London.
There are plenty of projects out there to finance and in the US alone the municipal bond market runs to trillions of dollars. Just a tiny a portion of that funding could be used to back a welter of themed environmentally friendly projects. At present, much of the money raised by munis is loosely classified, often for general operations, thereby not catching the attention of the growing specialist SRI investor base.
“Municipalities have been funding environmentally progressive projects for a long time — they just haven’t been labelled as green bonds,” says Jeff Epstein, a founding partner of the Green Muni Fund, which aims to be the first tax-free municipal bond fund that invests in environmentally beneficial bonds only.
“We estimate that out of the roughly $4tr of [US] municipal bonds outstanding today there are $500bn that, at least on the surface, could fit into a ‘green’ category. But many of these are not easily defined and it takes a lot of work to discover whether the bonds match our environmental standard or not.”
The potential numbers are big. Christopher Flensborg, head of sustainable product and product development at SEB, estimates that as the market develops over time, eventually issuance could make up 10%-15% of the whole bond market.
State of Massachusetts became the first US municipality to print a specially structured green bond in June, when it priced a $100m bond to finance environmentally sound infrastructure projects as part of a $675m general obligation offering.
While the whole issue was originally intended to be $1.1bn, the green tranche attracted strong demand with $130m of orders. The state expects to sell more green bonds in the future.
Other states and local governments should be queuing up to join in.
“There’s been exponential growth in the money under management for SRI funds and there’s a scarcity of eligible fixed income assets,” says Brown at Citi. “A local government or municipal green bond would be well received — as long as the issuer is happy to ring-fence proceeds and commit to reporting. Every public administration should have interest in coming to this market — it’s surely a vote winner.”
Because municipalities and governments are public bodies, helping to develop a market that raises money for socially responsible projects should be an attractive option to many — as long as the public they represent supports it.
“Whether the specially structured SRI muni bond market grows depends somewhat on how the public responds,” says Stephen Liberatore, portfolio manager of TIAA-CREF’s social choice bond fund in New York. “It’s a case of whether green bond issuance or socially responsible issuance will be supported by residents and or voters. Other states have done bonds with societal or environmental impact — the State of Michigan for example issued bonds to fund energy efficiency. Public utility districts might issue bonds used to fund renewable energy projects such as wind, hydro or solar.”
What’s in a name?
A lot of SRI investors judge US muni bonds to be eligible in their portfolios anyway, which may raise the question of why an issuer would go to the trouble of structuring a green or environmental bond when it can access the SRI investor base without doing so.
Liberatore’s fund at TIAA-CREF generally views municipal issuers as being socially responsible, as long as they meet its proactive social investment framework, which can address a general entity or go down to assessing specific projects.
But the branding involved with a specially structured bond could be helpful to issuers.
“The green bond label has a market advantage,” says Liberatore. “People have a clear idea of what a green bond is so it could well be that that is the best label for issuers to use in marketing. But there are lots of ways to make a positive societal impact, such as affordable housing, or vaccine bonds. It doesn’t have to be just ‘green’.”
By issuing a specially structured bond, a state or local authority could also access investors who cannot buy their usual offerings because the specified use of proceeds do not quite fit their investment criteria.
Government issuers may not meet some investors’ environmental, social and governance (ESG) targets with a non-themed deal alone.
Governments and local authorities may contribute to defence budgets, or finance forms of energy which belch out carbon. So a product that can assure investors that their money is going where they’d like it to could open doors to new investors.
On top of that, investors may be open to buying municipal paper because of a lack of other options out there — if the SRI themed market grows, which it looks set to do, issuers that do not address SRI investors directly could risk losing their attention in the long run.
“As the green bond industry gets more established it will be much easier for investors to buy investments where they know the proceeds are going to fund environmentally friendly projects,” says Epstein at the Green Muni Fund. “The Clean Energy and Bond Finance Initiative has the goal of getting $5bn-$20bn of new bond issuance to fund renewable and energy efficiency projects over the next five years — some of which would be muni.”
Investor behaviour is also changing. Many not only screen their portfolios against what they consider harmful industries, such as tobacco or guns, but also buy assets which directly fund SRI projects. This active investment is expected to increase.
“We will see increasing investor demand for positive investments, rather than just the previous method of screening their portfolios for negative externalities,” says Andrew Salvoni, vice president on the SSA syndicate desk at Morgan Stanley in London. “Investors will look to increase the proportion of their portfolio that has active investments in SRI projects.”
Going green certainly helped Massachusetts access a new investor base, according Jon Carlisle, communications director for the State’s Treasury: its green offering attracted new buyers to the Massachusetts name, both individuals and institutions.
“We see lots of opportunities for Massachusetts type issuance,” says Ryan Chapman, partner at the Green Muni Fund. “That’s great for us. California has funded at least $3bn in light rail and commercial projects through bonds which we wouldn’t be able to buy because the use of proceeds is specified as for general operations.”
European opportunities
The US has a well established municipal bond market, whereas in Europe many local authorities don’t access the bond markets directly.
One way in which European local authorities could potentially access the market, without setting up issuance programmes to sell directly to the market, is through a combined issuer — such as a municipality financing agency — issuing a green bond.
But it’s not just local governments and municipalities that are ripe for green issuance — sovereigns may also get in on the act.
“In a year’s time we could be seeing municipalities, corporate borrowers and financial institutions, plus possibly a couple of sovereigns, looking to issue green bonds or a sub-theme of green bonds,” says Vince Purton, head of debt capital markets at Daiwa Capital Markets Europe in London. “That will offer real diversity to investors. We were approached by one sovereign looking to see if an energy-related SRI bond could work. But sovereigns, like other asset classes would need to discuss internally the practicality of compartmentalising use of proceeds in benchmark size for any SRI project.”
Is greener cheaper?
An issue which is structured as a green bond doesn’t offer any concession to an issuer in terms of cost of funds — and market participants believe that that is the best way to develop the market.
Most SRI investors believe they should be remunerated just like any normal investor. It would be hard to ask them to behave otherwise — the industry will not grow if investors have to take below-market returns for making an ethical investment.
For one thing, it will be hard to ask end investors to put their retirement savings, for example, into a pot that would provide lower returns than the market benchmark — any warm and fuzzy feeling they might get for having put their money to work to fund SRI projects probably won’t last if they find their pension dwindling and can’t afford to heat their home in their old age.
But it is possible that in a mature market green or other themed SRI bonds may bring pricing advantages for issuers.
“We agree that you can’t ask an investor to take a haircut because what they’re buying is SRI, we’re looking for similar returns along an industry benchmark,” says Chapman at the Green Muni Fund.
“That said, we hope the market will evolve to the point where the benefits of printing a green bond is clear to an issuer. There is no difference at the moment between pricing of a muni bond for green projects, or a standard one, but in 10 years’ time we’d think it’s possible that you’ll be able to show a single-A rated green bond trading at the same levels as a double-A rated normal bond.”
But even now, some issuers say that going down the SRI route has brought them advantageous financing.
Bonjour SRI
In March 2012 French region Île-de-France became the first French region to sell an environmentally and socially responsible bond — a €350m 12 year deal arranged by Crédit Agricole and BNP Paribas. The proceeds were to be split half and half between environmental investment projects and for social uses such as the construction of affordable housing and assisted living facilities for vulnerable members of society.
The deal was heavily oversubscribed. “The transaction was done very quickly. In less than an hour the orders were nearly twice the €350m the region had raised, namely an oversubscription of 1.75, exceptional for a local community,” says a spokesperson for the region. “The innovative aspect of the operation attracted a large range of investors and this increased significantly the sums raised. The banks involved said the orders received were 25% more than for a standard operation. This enabled the region’s interest rate to be lowered, the lowest obtained by a local community on the markets since the beginning of the year.”
Île-de-France is looking at selling another SRI bond between now and next year, and hopes to attract investors from the UK, Holland and Scandinavia. It would also like to enlarge the range of projects that the bond funds.
Even for those issuers that are not open to selling a themed SRI bond, meeting ESG criteria is becoming increasingly important — in the long term an issuer’s ESG performance could begin to affect the pricing on their bonds.
“If you have several issuers, and one has a better management of the environment, you could argue the risk-adjusted return is lower,” says Flensborg at SEB. “But it’s far too early. Long term, and issuers with higher transparency and higher awareness of environmental issues will potentially have better pricing.”
This even works on a sovereign level: the Principles of Responsible Investment Initiative published a paper in September finding correlation between ESG factors and credit risk in sovereign debt, finding that sovereign debt issued by countries with higher ESG scores outperformed in the euro sovereign debt crisis.
Reporting: a necessity
One of the problems that new issuers to green or SRI bonds have to consider is reporting, and government issuers are no exception. SRI investors demand high standards of reporting and transparency from issuers, so that they can ensure the bonds they are buying meet their criteria.
Île-de-France, for example, had a rating from Vigeo, a firm which assesses organisations’ performance on environmental, social and governance issues. The region says it found that helpful when meeting investors on a roadshow ahead of its SRI bond.
What is key to getting a successful deal away is being as transparent as possible, and listening to what investors want. “Massachusetts’ objective was to finance environmentally friendly projects and they have committed to ongoing disclosure,” says Liberatore at TIAA-CREF. “In the dialogue running up to the deal we were one of several investors pushing for increased disclosure on the use of proceeds and the reporting. Massachusetts was very responsive to that feedback. They set up a separate part of the state’s website specifically for reporting on the environmentally friendly projects that the bonds were set to fund. The deal ended up as a very good result for the issuer and for investors.”
The amount of extra work involved is not too onerous, says Carlisle at the Massachusetts Treasury: “It did not require substantially more work in terms of disclosure. That said, we have committed to ongoing reporting on a regular basis so investors can see that the sale proceeds are going to green projects. From our perspective, the benefits of offering this new product to investors far outweigh this additional reporting.”
And municipalities, as they often market to a more local investor base, may not need the same standards of reporting as other issuers might to attract demand. Massachusetts, for example, did not ring-fence proceeds against specific projects, but said what kind of projects it would use proceeds for — and investors got comfortable with that.
But what, how and how often, details of the use of proceeds on a themed bond issue should be reported is still very much up for discussion. On the one hand, too much regulation too early on could constrain the market, but without some form of standardisation investors could get hurt — and that could damage the development of the market.
“I’d like to see issuers, banks and investors working together to propose some sort of framework, for a set of guidelines, getting everyone involved,” says Navindu Katugampola, vice president in SSA DCM at Morgan Stanley in London. “We need to make sure that these guidelines meet certain criteria and increase transparency if we want to attract more investors to the asset class.”
