Green bonds face heightened levels of scrutiny from sceptical investors, and that should be welcomed, according to Franklin Templeton’s head of European fixed income, David Zahn.
In a white paper, entitled ‘Green bonds: seeking new opportunities to invest for good’, Citywire + rated Zahn and fixed income ESG analyst Gail Counihan broke down the current state of play for green bonds.
One of the core takeaways from the report was around the question of whether green bonds actually make a difference. Here, the pair wrote:
“Green bonds have faced a certain amount of scepticism. Some investors harbour suspicions that green issuance is simply an attempt to rebrand a company, without changing any of its climate-damaging behaviours. We view this level of scrutiny as welcome and valuable in a market that is still in its early stages. We think it is essential to consider the broader strategy and behaviour of the issuer, its environmental performance and track record, and whether the governance and management in place can ensure successful delivery of the project.
Looking at the make-up of the market, Zahn and Counihan said the green bond issuance is currently over-subscribed, which means there will be a healthy secondary market for the bonds. However, one of the major developments needed in this area is to secure capital for the long-term, which will allow the money to be drawn down and used for green projects.
In periods of risk aversion, anecdotal evidence has suggested green bonds may exhibit lower volatility as investors tend to hold on to these bonds. However, while it is too early to mark this as a trend, in the future, we believe lower volatility could develop into green bonds permanently trading tighter to the issuer’s yield curve, particularly for longer maturities.
Lower volatility could also create opportunities for active managers to switch into bonds at longer maturities, with consequently higher spreads, without having an unacceptable impact on potential short-term volatility. In our view, there is also the possibility that national governments could offer incentives; this could be especially useful in compensating investors for committing capital to longer-term climate projects.
With plans focused on climate change-abatement efforts in Europe needed huge swathes of committed, long-term capital, Zahn and Counihan said the existing array of sovereign green bonds may not cover these capital requirements. Again, the pair said investors would need to see some defined benefit to investing in green bonds for the longer-term.A mixture of corporate, sovereign and EU-backed bonds may be needed to bridge the gap between the investment backed by the EU budget and the required total. Policymakers are also keen to persuade investors to support much longer-term issuance to better match asset lives, and this may require incentivisation.”
Source Citywire Selector