Issue 250: 2020 10 08: Guilt-Free Gilts

8 October 2020

Guilt-free Gilts 

Green UK Government Bonds

by Frank O’Nomics

I never had you down as an arms dealer. I didn’t think that I had the remotest involvement either – but it turns out I was wrong. Many of us have tried our best to salve our consciences by ensuring that our investments conform to the highest environmental, social and governance standards (ESG). Yet the core holding of many pension pots, the so-called “risk-free asset”- government bonds – may be tainting the whole process. We may avoid investing our savings in the shares of those that manufacture tanks, fighter jets and nuclear submarines, but it is very hard to avoid having some of our investments in the governments that buy them. There is, however, a potential alternative.  Many governments have started to raise additional finances via an issuance programme of green bonds, the proceeds of which are used solely for socially or environmentally beneficial causes.

The most notable green bonds have generated funds for renewable energy, energy efficiency, clean transport and sustainable land use. The important thing is that these funds are ring fenced from other debt and that the issuers report regularly on their use. The first sovereign issuer was Poland in 2016. Poland is historically a big consumer of fossil fuels, and the green bond proceeds are being used to develop their renewal energy resources, helping them commit to carbon neutrality by 2050.

Last month saw the issuance of one of the largest sovereign green bonds yet, as Germany issued Euro 6.5 billion 10-year bunds. If there was any doubt that there was demand, the fact that the deal was 5 times oversubscribed should be sufficient answer.  France, Ireland and the Netherlands have also issued green bonds, and Spain and Italy have them under active consideration.  In Africa they have been issued (this week) by Egypt, and in South America Chile were the first issuers last year. Over Euro 100 billion of green bonds have been issued this year, from governments, supranationals and corporates. Mercedes Benz issued Euro 1bn bonds to fund the development of emission free vehicles, for example.

So why hasn’t the UK government issued green bonds already? One of the historic arguments has been that they would only be issued if there were a clear benefit to the taxpayer – more expensive to the investor than existing government bonds. Why would investors suffer reduced returns for being ethically exacting? In addition, there is an additional expense that comes in the extra reporting and monitoring requirements involved in green issuance.  A more cynical explanation may be that the government does not want its creditors dictating how it spends its money.

The growing wave of international green bond issuance has undermined pretty well all of these concerns. The massive increase in the need to issue government bonds to fund Covid-related measures means that any new green bond issue could be highly liquid almost instantly, negating the need for a liquidity premium. Central government borrowing in the first 5 months of the year was £221bn, 11 times greater than the highest ever cash borrowing figure at this time of the year. This was an opportunity to diversify the mix of government bonds by issuing some that were green. However, that opportunity has not disappeared, with potentially a further £70bn needing to be raised. Issuing bonds with the same maturity as existing non-green issues, as in Germany, may make pricing easier, but there is an equally strong argument to fill in gaps in the maturity calendar, thereby creating demand from liability matching investors. However, perhaps the strongest argument on the supply side would be that they would create benchmarks against which corporate green bond issuance could be generated. Car manufacturers and diversifying fossil fuel companies are likely to be at the front of the queue.

From a demand perspective UK investors need the facility to invest in green bonds and currently, beyond a few modest deals, there are very few that are sterling denominated, and none that are government backed. The government has set itself demanding targets for net zero carbon emissions within 30 years and no new petrol or diesel cars within 15 years. This will take a lot of funding and would provide a perfect opportunity for funds that are under pressure to demonstrate their sustainability commitment to their underlying investors – you and me. In short, green bonds would sell like hot cakes.

Green bonds may not be a cause celebre or a vote winner, but they do seem to be inevitable. This is the era of the activist investor. If we don’t like the way companies are behaving we can attend their meetings and vote the management out of office, or we can vote with our feet and sell the stock. The same is not true for governments. A significant number of direct and indirect holders of gilts will not have voted for the government and there is little they can do to influence the way their savings are spent. The facility to invest in bonds that are ethically sound exists in most of the rest of Europe – its time that it did here too.




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