By Hamlin Lovell, NordicInvestor

September 2020 saw record issuance of green bonds, and a strong pipeline of supranational, sovereign and corporate issuance lies ahead, partly accelerated by Covid-19 recovery and carbon transition spending. There are high hopes that the new EU rules will not only harmonise standards for green bonds but could also define a global standard. Yet challenges remain including data and technical issues, and expanding the concept to credit asset classes such as asset backed and mortgage securities.

                                    Panelists from left to right; Søren Larsen, Rune Riisbjerg Thomsen and Douglas Farquhar

NN is a global asset manager with a philosophy that responsibility extends beyond short term financial gains.

There is a strong link between the positive impact of ESG integration and better risk adjusted returns. All products across all asset classes apply ESG in one of three ways: ESG integration, sustainability, and impact….

– Douglas Farquhar, Client Portfolio Manager, Green Bonds, NN Investment Partners.

PKA is a Danish pension fund that has also embedded ESG across all asset classes

We view green bonds as posing less non-financial and reputational risk. We see green bonds as a way to contribute to the green transition within the credit space. What’s not to like if you can get roughly the same yield and have a positive impact….

– Rune Riisbjerg Thomsen, ESG Analyst, PKA Pension

Nykredit is both an issuer of green bonds and an investor in them. The mutually-owned firm builds on two centuries of experience in mortgage finance and is also an asset manager.

Doing things together is part of the DNA of the Danish system of mortgage finance. In 2020, our pension fund playing its part in societal recovery by expanding lending to homeowners, companies, and citizens, and supporting sustainable housing. Sustainability and returns go hand in hand….

– Søren Larsen, Head of ESG and Sustainability, Nykredit.

Defining a green bond and avoiding “greenwashing”

The current system of self-assessment combined with a disparate range of standards and labels gives rise to differences of opinion over how to define green bonds. NN subscribes to multiple external data sources as well as carrying out internal screening, and has built its own green bonds database to form its own opinions on whether bonds with a green label should be defined as green.

Some index providers have also developed their own methodologies for selecting green bonds, but there are concerns about whether their research will prove to be thorough enough.

Passive index investors who do not make an effort to ensure that bonds are genuinely green are not only taking reputational risks, they could also be forced into a secondary market sale of any bonds that lose the green label….

– Douglas Farquhar

This could happen in 2021, when the upcoming EU taxonomy of green activities and definition of green bonds, including frameworks for use of proceeds, and benchmarking, comes into force. The EU rules are welcomed by all three participants. A regulatory watermark should be a bulwark against “greenwashing” and create a best in class standard, supported by independent, external third party reviews.

Europe leads the world in ESG and may also do so in the green bonds space;

If non-EU countries follow the rules, as Japan has committed to, they could also become the de facto global standard….

– Douglas Farquhar

Of course, asset managers could still have different perspectives on certain issues. One contentious question is whether carbon intensive companies should be able to issue green bonds. The reality is that many of them will have to do so in order to finance their transition to lower carbon business models. Therefore, NN will contemplate investing in a bond linked to a renewable energy project even though the issuer is an oil company. In contrast, NN does not approve of the Danish Government proposal to add green labels to conventional bonds.

Issuance pipeline

Denmark’s impressive ambition to cut its carbon emissions by 70% by 2030 is one factor that has helped the green bond market grow to around EUR 650 billion as of September 2020. Covid-19 has accelerated issuance of green bonds, and also of social and sustainability bonds, which share some of the same terminology (some sustainability bonds can also be classified as green bonds).

The pandemic has increased interest in ESG investing more broadly, by raising awareness of climate change, and by fostering a greater sense of social solidarity within and between countries – we live in a global village and we are all interconnected….”

– Søren Larsen

One third of the EU Covid rescue plan – or around EUR 225 billion of bonds – will be green bonds. Meanwhile, Germany, Luxembourg and Sweden are issuing their own green bonds. Germany in particular is building a green bond yield curve by issuing at multiple maturities.

A greater supply of green bonds is welcome since it would create more liquidity, and might also improve yields, which are being driven down by strong demand for new issues.

Corporate issuance is growing, and collaborative conversations amongst investors and companies are helpful to encourage more corporate issuance. Investors need to engage with companies to feed back their criteria.

We manage strategies containing both sovereign and corporate bonds, but our pure corporate bond strategy launched this year is growing fastest and we expect it to become our largest fund”

– Douglas Farquhar

We have not historically been very active in corporate bonds, but the EU taxonomy could help us to grow in this area….”

– Rune Riisbjerg Thomsen

Moving into the mainstream

Should green bonds be seen as a separate asset class or as part of overall fixed income portfolios? The consensus is that they are moving into the mainstream.

We treat green bonds like any other asset. They are part of our repo and collateral. It would be dishonest to treat them differently

– Rune Riisbjerg Thomsen

Green bonds have the same credit quality, duration and yield, and are moving from dedicated mandates to normal fixed income allocations…”

– Douglas Farquhar

Broadening out the asset class

Notwithstanding the impressive and accelerating issuance trend, the market is not yet broad enough to satisfy every type of fixed income mandate. The sector is mainly investment grade so it would be difficult to build a diversified high yield portfolio of green bonds. And green bonds currently are mainly sovereign or corporate and it is not clear how some sorts of asset-backed securities, such as mortgage-backed securities, can be accomodated.

Danish mortgage bonds have a huge potential for financing the taxonomy activities, but we need to solve the question of grandfathering urgently as most mortgage bonds have a duration of 20 or 30 years….

– Søren Larsen

Even within the corporate universe, some sectors such as autos are under-represented though issuance from Daimler and VW in 2020 is starting to redress this balance…

– Douglas Farquhar

Technical details to finalise

Indeed, a number of technical details need to be firmed up at the European level and all stakeholders need to work together to craft solutions. “The devil is in the details” says Søren Larsen.