Green Sovereign Bonds: Tactical Moves on an Emerging Market

China was expected to step in first, but it was France that announced, early September, the launch of the first Green sovereign bond. A political move, for sure, in line with the leading position assumed by Paris in the global energy transition since COP21. But behind this political “coup” lies a significant development: the sovereign debt is not just any segment of the bond market: it is thereference segment, whose main assets (the US 10 year or the German Bund) determine the trend. Besides, the French security was issued by Agence France Trésor, an institution that is itself a reference for its remarkable management of the (huge) French public debt. So things are getting serious.


The amount is modest: we heard about 9 billion euros over three years, a figure that has to be compared with the 200 billion debt issued each year by Agence France Trésor. But it is not insignificant when compared to the issuance of green bonds. The World Bank is proud to have issued $ 9 billion in green bonds since 2008, as the total issuances in 2015, all actors comprised, amount to about $ 35 billion.


In fact, the French decision, presented as a world premiere, is mainly an expected step in the development of these atypical securities, which appeared in 2008 and should be, in a few years, part of the financial landscape.


The rise of green bonds

Green bonds appeared in the 2000s and their development is linked to one form or another of public support.


In the US, for example, it is an amendment to the America Jobs Creation Act of 2004, the Brownfields Demonstration Program for Qualified Green Building and Sustainable Design Projects, which popularized the term and gave the first impetus to these specific bonds, designed to fund the remediation of industrial sites, conveniently supported by a tax reduction. The US Treasury has even directly initiated some emissions, by providing its surety, but the US government was not the official borrower: that’s why they cannot be termed sovereign bonds in the strict sense.


Various national initiatives appeared in the following years, such as the Climate Awareness Bonds of the European Investment Bank – the first bond issued simultaneously within all member-states, with the objective to finance projects integrated in the EU energy-climate package. But it was the World Bank that would significantly expand this until-then ultra-marginal market.


Its first green bonds were launched in 2008. This year marked by the crisis and the demand for healthier finance is a decisive year in the rise of themes such as the climate change and the energy transition, with the prospect of the Copenhagen summit the following year. Copenhagen will be a failure but, in 2008, the initiative of the World Bank is in the air.


The World Bank’s diagnosis is simple: climate change is affecting the entire planet, but southern countries will suffer the hardest hit. Recent advances in life expectancy, poverty reduction, improved health conditions and agriculture development could experience major setbacks. It is urgent to act, and this action requires unprecedented international cooperation. At the political level, it involves the Conferences of Parties. At the economic level, it concerns financial flows, and the Bank hopes to direct them to projects within its Strategic Framework for Development and Climate Change, aimed at stimulating and coordinating efforts, both in the public and private sector. The green bonds are the tool that will definitely do the signposting.


The initiative can also be perceived as an opportunity: institutional investors –  particularly in Nordic countries –expressed for many years a demand for such instruments. The World Bank’s green bonds were consequently designed with Skandinaviska Enskilda Banken and aim to meet certain criteria, including the AAA certification. The first issue, with a maturity of six years and a 3.5% interest, was a success and, most significantly, its performances were above average in the secondary market.


Since then, various groups of investors have advanced to choosing the very long term, a dimension that is often associated with green investments. This is particularly the case of the Long-Term Investors Club led by the Caisse des Dépôts et Consignations. The demand exists and is growing strongly.


The green bonds market today

The World Bank’s attempt has proved a success. Since 2008, it has launched 125 programs in eighteen different currencies. The diversity of these deals blends into a unified set of guarantees, which are all summed up in one: the quality of the World Bank’s signature.

The global market for green bonds is expected to reach between 50 and 60 billion in 2016. A detail, compared to the 100,000 billion in the global market. But it still represents a segment growing strongly, with a fourfold increase in four years. The main actors, on the issuers’ side, are local authorities (e.g. States in federal countries, municipalities, etc.).


The World Bank and its subsidiary International Finance Corporation remain major players over time, but their relative share decreases. In 2016, international institutions no longer issue less than 20% of loans.


As noted by Morgan Stanley’s analysts, the profile of issuers is changing with the arrival of private banks and large companies (including Apple, now in the world’s top 10 borrowers in this market, and EDF, France’s main electricity provider, which raised 1.4 billion euros in 2014). A Standard & Poor’s report released in 2014 noted that large companies see green bonds as an additional source of funding, providing access to a broader investor base, to fund efficiency measures with an environmental dimension. Greenwashing? No, because investors are quite vigilant; we could rather call it a sense of opportunity.


Besides, access to green funds is not so easy. The State of Victoria, Australia, was recently proud to have issued the first public bonds to receive the Climate Bond Certification, a label awarded by an initiative based in London and whose criteria are strict. Certification and standardization are therefore in the process of shaping a market in which the main investors, who manage billions of dollars, are under scrutiny and can afford to pay close attention.


Still, the range of projects supported through the Victoria’s green bond is wide and shows the variety of topics within the field of sustainable development: it is about financing (but also refinancing) public investment in energy efficient sectors such as renewables, sustainable public transport, and water treatment. This includes public lighting by LEDs, mini-hydroelectric plants, low carbon buildings, the Melbourne’s Metro tunnel, a railway track and the development of a renewables-fueled power plant.


It is in China, a country that has literally rushed in the energy transition, that one can find the largest borrowers today, representing 40% of emissions in 2016. The Shanghai Pudong Development Bank is on track to borrow in only one year what the World Bank borrowed since 2008. The renminbi is also the first currency used, with a little over 30% of transactions in 2016. The other countries are the United States and, in Europe, the Netherlands, Germany and Sweden. India is also in good position.


Will the involvement of sovereign States change something?

Paris’ decision, probably followed by similar announcements from Beijing and Washington, sounds the arrival of sovereign states among borrowers. Does is change something? If yes, why? To answer this question, we must go back to the question of the borrowers’ opportunism.


Some disgruntled observers might indeed wonder whether the so-labeled projects would not have been conducted anyway. Climate change and energy transition are among the largest public investments in the next decades. Governments keep investing (and borrowing), they just modify their priorities. Then do they really need to use green bonds?


A first answer is that the issuance of these bonds allows governments to manage from the start an access to increasingly important capital flows dedicated to the green economy, particularly among institutional investors – the very investors that fund the sovereign bond market. One could argue that governments today finance themselves at very low rates and have little need to diversify their sources of funding. But it’s still useful to get used to managing these new tools, and to do it early.

Besides, the governments’ interest do not only amount to their position as borrowers. Let’s consider the matter from another angle: the green bond market has everything to gain from the arrival of these new issuers, and government may wish, for political as well as strategic reasons, to develop this market.


A decisive element in the normalization of this market is in fact to enable investors to have at their disposal a range of more diversified assets, including sovereign bonds, enabling them to balance their risk-taking. This was precisely what the World Bank would do, in hosting (thus guaranteeing) AAA-rated issuances. It would help each of the guaranteed issues, which benefited from low rates, but also the whole green bond market, reinforced by the presence of ultra-safe assets. The coming into play of sovereign states is a new step in the same direction. This is good news, which opens onto a faster maturation of the green bond market.


But saving the planet is not the only, and probably not the main objective of the governments who make their first moves in this emerging market. As first comers, they want to understand the rules, bend them as needed, and be able to capture some financial flows. This is certainly one of the stakes of the French decision: to make the Paris stock exchange a reference in this new segment of green sovereign bonds, through creating a turnover and developing skills that will enable Paris, when facing London, New York or Shanghai, to stay in the race.