4,000 buses coming
The green borrowing strategy of the UK government kicks off soon with the sale of the first green gilt. It is highly anticipated by investors. For me it is symbolic as it marks the prioritisation of green projects which are necessary for the UK to meet its net zero ambition. Where the public money goes, private money will follow. By using bonds to ramp up investment, governments will open the way for new investment opportunities.
Ready for the green gilt
Last week the UK’s Debt Management Office announced that the inaugural UK Green Gilt will be launched in the week beginning 20th September. The bond – set to mature on July 21, 2033 - will be sold through a syndication and the talk in the market is that it will fly off the shelves. The UK government has pledged to issue two green gilts this year raising at least £15bn. The expectation is that the size of the first bond will be in the region of £8-£10bn with a coupon of around 0.75%. It comes after Spain issued a green “bonos” this week, raising €5bn for a (slightly over) 20-year bond with a coupon of 1%. This issue was more than twelve times over-subscribed. The sovereign green bond market is go!
More to come
More and more sovereigns are issuing green bonds and, as is the case with most of them, the intention of the UK government is to continue issuing green gilts to build a liquid green gilt curve. In its revised borrowing requirement for the fiscal year 2021/22, the unallocated proportion of the total planned amount of gilt issuance (between conventional and inflation-linked and by maturity) was 10%. That suggests capacity for additional green gilt issuance in the first part of 2022 will be around £10bn. I will not be surprised if it is higher than that and for 2022 as a whole, we could be looking at anywhere between £25-£50bn.
The projects are key
This is good news. To be accredited as a green bond there has to be absolute clarity that the proceeds will be used to finance climate change related projects. The UK government has stated that at least 50% of the proceeds from each issue will be used to finance new projects being launched in the coming two years after the issue. The rest is earmarked for financing projects already underway. In its Green Finance Framework, a number of priorities were identified - clean transportation, renewable energy, energy efficiency, natural resources, climate change adaption and pollution control. If executed properly, the green gilt programme will allow a significant amount of new investment into green projects in the UK in the years ahead. Where public money goes, private money will follow.
No time for fiscal tightening
The pandemic has increased government borrowing across many countries. The debate on fiscal policy is heating up and the German elections and the possible leftward tilt of a new government will add to this. Hopefully, there will be a recognition that spending on climate change needs to be seen as additional to business as usual and that greater flexibility in deficit and debt management is needed. While this week’s announcement of increased National Insurance rates to finance higher spending on health and social care in the UK is seen as fiscally neutral, it is contributing to an increase in the overall tax burden and to what many will feel like a negative fiscal impulse. Europe, on the other hand, is experiencing a positive fiscal impulse – especially when the funding of the NGEU really kicks in. My market conclusion from this is that Euro/Sterling might be on course from one of its period journeys to 0.90 £ per Euro. Hopefully, green spending in the UK may provide some offset to the fiscal tightening through the potential multiplier effects.
Bonds at the heart of green financing
Back to green issues. The debt markets have a critical role to play in activating global savings to the cause of zero carbon. Equity markets can reward the companies that are contributing to the technological transformation and showing best practice across a range of ESG factors and, of course, reward investors because earnings growth should be positively correlated with activities that are green. But bonds raise money for new investment and government bonds can do that in size. In the wake of green spending by governments, private capital will follow – the UK is proposing to finance the purchase of 4,000 electric- or hydrogen-fuelled buses, it will be funding low-carbon technologies that have the potential to grow, and it will finance the development of new carbon capture projects. Scale that up internationally and the amount of money going into green investment is huge. It needs to be and it needs to be even bigger.
Low yields should encourage long-term borrowing
Spain’s green bond came with a coupon of 1%, the UK’s is likely to be less than that. All three of Germany’s green bund issues have a coupon of 0%. The debt markets make it incredibly attractive to issue long-term debt instruments to finance the fight against climate. I keep hearing there is too much debt in the world and that means rates can’t go up and we will have inflation and financial instability. Referring back to my note of a couple of weeks ago the problem is not too much debt but not enough (in other words, too much saving). If we are worried about the debt/GDP ratio then we need to focus on the denominator. Not doing enough about climate change will reduce the growth in GDP. Spending now and in years to come will boost growth, creating the potential to reverse long-term declines in productivity and reduce external costs and risks.
Refinancing is saving money
The UK has three gilts maturing in 2022 for a total of around £100bn. The weighted average coupon is 2.27%. Refinancing that debt will realise massive savings in interest payments for the UK government. Yields might go up a bit over the next year but if that debt is refinanced at 1% less than the current coupon rates it saves £1bn in interest costs per year. That creates fiscal space as well as more flexibility on spending. Issuing long-term debt to finance green projects is clearly the right thing to do and while the direct returns to investors in gilts will be low, the indirect impact on long-term financial returns and economic growth could be meaningful.
Huge scope for raising share of green assets
Institutional asset owners and their asset managers need to de-carbonise portfolios by increasing the share of “green” assets. That will happen by the natural refinancing of debt assets when they mature or by switching out of existing non-green assets into positive climate focussed assets. The scope for this is huge globally. Sovereign green bonds must be at the core of investing in the green transition and by financing projects at incredibly low cost they create investment opportunities for private investors in credit and equities. Someone has to build 4,000 buses.
Bringing the masses
The other nice thing about the UK’s funding strategy is that it is offering ordinary citizens the opportunity to participate in financing green projects through its national savings offering. For as little as £100, UK citizens can buy into a savings product linked to the green gilt framework. These little things are important in shifting the culture towards a more climate aware one at all levels.