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AXA IM's Olivier Vietti comments on the development of the global green bonds market in 2018

AXA IM's Olivier Vietti comments on the development of the global green bonds market in 2018

Market commentary
12 January 2018

Olivier Vietti, manager of AXA IM’s Planet Bonds strategy, comments on the development of the global green bonds market in 2018 following strong growth last year.

Key points

  • The green bond market continues to develop at a significant pace, with particularly strong demand from institutional investors; growth mode will continue in 2018
  • 2017 was another record year for green bonds with more and more investors attracted to this market as a tangible route to investing in the low-carbon economy
  • However, selectivity remains key with an increasing number of new issuers entering this market
  • 2017 was marked by green issuance from different governments, in particular the French government that issued EUR 9.7 billion of green instruments last year (source: Climate Bonds Initiative, as at end of 2017)

Global green bond market continues to expand

The green bond market continues to grow, offering investors broader investment opportunities, as more than 200 issues are available across major green bond indices. As at the end of 2017, there were more than US$120bn in new issuance volumes, making it a record year for green bonds, after US$90bn in 2016 (Exhibit 3).

While the first issuances were predominately from supranational entities (the European Investment Bank issued its first green bond in 2007), the market only started to grow in earnest in 2012, as large transactions were completed by issuers from the supranational and agency sectors. In the following year, the first truly sizeable green bonds were issued by large corporates. The global green bond market has continued to develop at a significant pace and, as of October 2017, is now more diversified. As shown in Exhibit 1, supranational entities and agencies represent close to 45% of the global universe, followed by the utility sector (22%), banks (13%), corporate debt (13%), and government debt (7%). While continuously increasing, the number of issuers remains limited, at 103.

Meanwhile demand has been particularly strong from institutional investors. According to the Climate Bond Initiative (CBI), 54% of green bonds have been allocated to socially responsible and/or green investors. Institutional investors have a large share of green holdings as they have a particular appetite for this market – it offers transparency and environmental benefits at similar prices to non-green bonds from the same issuers.

Euro first currency of green bond issuance

In this high demand environment, pricing is key for investors. According to the CBI, most green bonds analysed in its sample priced in line with traditional new issuances. Additionally, on occasion, performance in the secondary euro corporate debt market has been higher than traditional bonds (this has however not been the case in the US dollar sector). Strong demand sees oversubscription ratios above 2 for euro and dollar green deals. European demand is particularly dynamic, probably highlighting the fact that the euro is the first currency of issuance, with close to 55% of the total green bond indices priced in that currency (Exhibit 2).

Liquidity has also improved significantly over the past two years, with bid/ask spreads compressing, allowing better trading in secondary markets. Existing issuers have continued to build their curves and the green bond benchmark transaction issued by the French State in early 2017 offered undisputable liquidity to investors.

2017: Robust activity in the European market

Activity has remained robust in Europe with more than 50% of new issuances coming from the European market. While 30% of the global issuances came from Chinese issuers in 2016, following Beijing’s attempt to deleverage the financial system, primary market activity in the country tapered off in 2017. However, we think this halt is temporary, and issuance will resume as China accelerates its green transition. And even with this decline, China remains the second biggest issuer after France. This year has indeed been marked by the issuance of green instruments by the French government, providing investors with a new asset class from a high-quality issuer to invest in – and a large issuance of €8.6bn to ensure liquidity. The European banking sector has also been particularly active, with issuance coming from a variety of different banks and countries.

Investing in the low-carbon economy

Although businesses are slowly beginning to favour the ‘green’ model, the world still looks set to overshoot the +2°C temperature rise target if no large-scale, dedicated actions are taken to cut carbon emissions.

Investors can adopt various strategies to support the transition, such as divesting from the most carbon intensive assets in their portfolios – the International Energy Agency, for example, recommends keeping 80% of today’s coal reserves in the ground – or investing in low-carbon projects.

In our view, the green bond market offers a tangible route to investing in the low-carbon economy. Green bonds are explicitly designed to raise capital for projects with clear environmental benefits, and there are now many issuers coming to the green bond market. As presented in the Exhibit 4, the CBI estimates that the green bond market may represent US$1 trillion in 2020.

Analysis and selectivity remain key

The green bond market continues to require due diligence in order to avoid the risks of aggressive marketing techniques. Being selective is key to raising the standards in this market. Selectivity and greater transparency indeed help ensure that the most relevant and impactful green projects receive the necessary financing.

In this respect, benefiting from strong research and insight into the issuers of green bonds is vital as the market is still in the early stages of development and investors should be mindful of potential cases of ‘green washing’, whereby inappropriate projects receive financing via the asset class.

As a responsible investor, the lack of common standards on green bond eligibility criteria in the global market require dedicated analysis. Proper monitoring and follow-up on green bond investments is necessary to ensure they are delivering on their promised environmental impact.

Conclusion

The green bond market is in growth mode. Driven largely by the interests of institutional investors, the market is poised to continue in its growth trajectory in the coming years. Nevertheless, investors should be mindful of the quality of the issuances and go beyond the Green Bond Principles in due diligence and quality assurance. Newer markets such as China will increasingly come on board with issuances over time. In order for the green bond market to maintain its growth, market participants across the board will need to ensure that the associated impacts are articulated, measured and transparent to meet the evolving expectations of investors.

Notes to Editors

Exhibit 1

More diversified across sectors

Source: BofA ML and AXA IM Research – As of 31/10/17

Exhibit 2

Source: BofA ML and AXA IM Research – As of 31/10/17

Exhibit 3

Another record year for green bond issuances

Source: Climate Bonds Initiatives and AXA IM Research – As at end of 2017

Exhibit 4

A growing share of the global green bond supply

Source: Climate Bond Initiatives (CBI) and AXA IM Research

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