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Green bond issuance set for record despite Covid-19

High investor demand, especially for energy transition bonds, set to be further boosted by introduction of German 'twin bunds'

Green bond issuance so far during 2020 has exceeded that of the same period in 2019, despite a temporary slowdown during the height of Covid-19, and is on track for a record year.

Issuance of all green bonds—which typically fund capital-intensive environmental projects—for the first eight months came to c.€132bn ($157bn). This exceeds c.€125bn for the same period in 2019, according to Dealogic data analysed by credit ratings company DBRS Morningstar. Last year, issuance hit a record after surging 51pc on 2018 figures.

"Last year, had a very strong level of growth, and 2020 was expected to be an even more significant year of growth—but Covid-19 hit and put a dent both in green issuance and capital market activity in general,” says Gordon Kerr, head of European structured finance research at DBRS Morningstar.

€132bn – Issuance of green bonds Jan-Aug 2020

“However, that slowdown has turned out to be only temporary. Issuance is slightly higher than at the end of August last year and, if anything, given the pause that we had, it looks likely to be a strong end-of-the-year."

Energy continued to play a leading role in the global green bond market in 2019, with almost a third of allocations (31pc) used to fund the sector, according to research by international NGO the Climate Bond Initiative (CBI). Energy’s share has fallen from c.45pc in the years before 2018, but this is largely due to the increasingly diversified issuer and project base of the wider green market.

Investor preferences

There is strong demand from investors such as asset managers, insurers and pension funds for green bonds, according to Sean Kidney, CEO of the CBI.

Almost two-thirds of European fixed income managers prefer green bonds where available and priced competitively with non-green equivalents, according to CBI’s 2019 research. It also found respondents wanted to see more energy green bond issuance.

"Since the 2015 Paris Agreement, all major investors have now worked on the basis that the world is going to change and governments are going to act on climate change,” says Kidney. “They also think green bonds will likely carry less risk going forward than non-green bonds. And if companies are issuing green bonds, investors often use it as an indicator that those companies are taking steps to be ahead of the transition.”

This year, National Grid-owned US energy firm Niagara Mohawk Power Corporation issued a 10-year green bond with an interest rate of 1.96pc. It was nearly four times oversubscribed, with around 110 investors placing orders. E.On secured a 1pc interest rate on its €750m green bond issue; significant investor demand led to eight-times oversubscribed orderbooks.

Corporate green bonds tend to offer yields up to 0.02pc lower than comparable non-green bonds, according to investment research firm MSCI, reflecting the sheer amount of demand for green bonds relative to supply. In the secondary markets, green bonds outperform equivalents, according to CBI’s research.

In a sign of increasing market maturity, the green bond market is set to benefit from the introduction of a reference asset—equivalent to the role of US Treasuries in the global financial system. The German government will soon launch €11bn of green "twin bunds" to raise funds for emissions reduction projects including energy. This will allow investors to swap green bonds with conventional German bunds and establish a reference for pricing green debt. The Swedish government has a similar plan.

Transition bonds

The CBI’s Kidney says investors are also increasingly interested in so-called transition bonds, which help high-carbon businesses transition to practices in line with the Paris Agreement.

In March, Cadent Gas launched the UK's first transition bond to retrofit its gas distribution network by focusing on and trialling hydrogen and low-carbon gases alongside fixing methane leakages.

“Last year, had a very strong level of growth, and 2020 was expected to be an even more significant year of growth—but Covid-19 hit and put a dent both in green issuance and capital market activity in general” Kerr, Morningstar

“Displacing a coal plant with a gas one in a jurisdiction using a lot of carbon-intensive fossil fuels, such as Alberta, probably offsets more carbon than creating another hydro plant in another jurisdiction relying nearly completely on renewables already, such as Quebec,” says Andrew Lin, head of infrastructure, power and utilities at DBRS Morningstar.

He says “there is a feeling here in North America”, which produces more greenhouse gases per capita than Europe, “that the green bond certification market is not going to grow to any material size unless transition bonds are included” within the taxonomy.

“A lot of bond investors require green certification. Meanwhile, the larger portfolio managers will have the expertise internally to assess for themselves whether green bonds meet their qualifications. As such, certified green bonds have more demand from investors than for non-certified green bonds,” he adds.

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