The U.K. government issued its first “green gilt” this week. The government was looking to raise 10 billion pounds from the bond sale. Investors submitted bids for more than 100 billion pounds, showing a massive appetite for this type of bond. A bid-to-cover ratio of over 10 times is rather impressive! What is a green gilt, and what can we learn about the future of the types of bonds governments might issue?

 

What is a green bond?

A green bond is any bond that is issued for the purpose of helping fund climate-related initiatives. It’s a relatively new type of bond, coming onto the scene in the early 2000s, but governments at the local, state, national, and even international level are tapping the market to help fund renewable energy projects and other climate change mitigation, adaptation, and carbon transition projects. A key part of any green bond is the disclosure and transparency around what the proceeds are used for. Depending on the repayment guarantees, green bonds can often trade at a “greenium” (green premium) to conventional bonds. That means that if a government issues a generic bond, it can expect to pay slightly moreperhaps between 2 and 5 basis points (bps; 100 bps equal 1.00%)in debt servicing cost compared with if it issued a green bond.

 

What is special about the green gilt?

The U.K. government wants to be a leader in sustainable finance, and this 0.875% coupon bond that matures in 2033 is the first step toward that goal. The bond proceeds are to be used for things like flood defence and renewable energy projects. The new U.K. green gilt priced at a “greenium” of 2.5 bps on September 21, 2021.

 

 

What other green sovereign bonds are out there?

The ICE BofA Green Bond Index (GREN Index)—a fixed-income index that is market capitalization weighted and represents global green bonds outstanding—has 935 issues with a combined market value of $768.1 billion dollars as of September 21, 2021. Issuers include banks, industrial firms, utility companies, governments, and government-related groups like the European Investment Bank, Asian Development Bank, and the International Finance Corporation. Sovereign issuance constitutes 15.9% of the index, currently spread as shown in the chart below.


 

What is the future for green sovereign bonds?

The market demand for the U.K.’s green bond debut was overwhelming. The bond with a maturity in 2033 is offered at a discount to comparable conventional gilt bonds of around 2.5 bps according to market participants (investors are willing to pay more for the green gilt and give up 2.5 bps in yield).

 

While the overall green debt issuance globally is increasing rapidly, sterling issuance remains very small at only 2.3% in the GREN Index. The U.K. plans to sell at least GBP 15 billion in green bonds this year. The market welcomes not only the increased liquidity but also the increased transparency in terms of reporting on the projects undertaken linked to this financing. Given the strong demand from pension funds and other institutional investors, we expect the green and sustainable sovereign bond market to grow very quickly.

 

In conjunction with the launch of new sustainable investment vehicles such as this, we are keen to support the development of clear ways to assess countries’ overall positions with respect to sovereign-level climate goalscomprising their climate risks and opportunities.

 

To this end, Wells Fargo Asset Management is very pleased to have recently joined the Advisory Council of the asset owner-led Assessing Sovereign Climate-Related Opportunities and Risk (ASCOR) Project. The project’s goal is to provide a common framework for evaluating countries’ sovereign-level performance on climate change issues.

 

How can green sovereign bonds help investors?

Green bonds—and, more broadly, sustainability bonds—are useful additional tools for investors to attempt to meet their objectives, both financially as well as from a sustainability and/or impact perspective. The green gilt issue is particularly relevant for investors with an existing allocation to U.K. gilts, such as pension and insurance companies with longer-dated liabilities, who may be interested in deliberately allocating capital in support of the U.K. green agenda.

 

Disclosure

Bond values fluctuate in response to the financial condition of individual issuers, general market and economic conditions, and changes in interest rates. Changes in market conditions and government policies may lead to periods of heightened volatility in the bond market and reduced liquidity for certain bonds. In general, when interest rates rise, bond values fall and investors may lose principal value. Investing in environmental, social, and governance (ESG) carries the risk that, under certain market conditions, the investments may underperform products that invest in a broader array of investments. In addition, some ESG investments may be dependent on government tax incentives and subsidies and on political support for certain environmental technologies and companies. The ESG sector also may have challenges such as a limited number of issuers and liquidity in the market, including a robust secondary market. Investing primarily in responsible investments carries the risk that, under certain market conditions, an investment may underperform.

 

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