2018 - 2019 Edition of Citi Perspectives for the Public Sector

10 written about, once carbon pricing becomes more broad-based, the tradability or traceability of financing linked to carbon could further allow green bonds to be differentiated by price. 7 6. Significantly Improved Benchmarking: The benchmarking of SDG performance and disclosures will increasingly be done by collaborative, voluntary partnerships between the UN, NGOs supportive of the SDGs and leading global corporates committed to reaching common annual reporting standards. Industry groups are also getting involved. The sustainability effort led by the Institute for International Finance is an example of an industry association advocating for standardized approaches to and disclosure of exposures and risks in the financial services sector. Improved metrics may even mean eventual investor differentiation between “light” and “dark green” commitments, or between marginally and deeply sustainable issuers. 7. New York Catches Up: The fact that Europe and Asia have led the charge on green and theme issuance is not surprising from a political perspective. However, this trend has had more to do with SEC risk in the USA than with politics. One of the risks of U.S. sustainability issuance has been aligning documentation and disclosure with high SEC standards. There is the potential that this will be resolved in the coming years, unleashing the 144a market for green and theme products. 8. Differentiated Liquidity: In addition, as more of the globally available ESG money finds its way “in size” to green and theme bond markets, we might expect differentiated liquidity between green and vanilla instruments. Again, say that theme bonds are issued by an EM issuer five years from now in a local currency market in which liquidity is a factor. One can imagine differentiated liquidity scenarios favoring Sustainability Bonds. 9. The New Normal: What if five years from now, green and theme are the new vanilla for bonds, and sustainability investments are clearly and consistently funded through sustainability issuance? In such an environment, one could imagine that issuers would be held to sustainability standards at a threshold above and outside of today’s use of proceeds parameters. Issuers without the willingness or ability to conform to such standards and issue only vanilla bonds would become outliers. In that world, we would see differentiated pricing due to large demand differentials and reputational risk factors. Issuers acting outside sustainability norms would price wide of their more sustainable peers. 10. Recourse and Remedies: What happens if investors are not happy with the quality of their sustainability investments after issuance? What happens if the theme bond proceeds were put to work appropriately, but the issuer’s sustainability behavior diverges from core principles? Or green obligations are separated from the green assets they funded through M&A activity, as we have seen recently? 8 Investors’ current recourse is to sell or to voice concerns to the issuer. With time and scaling demand, investors will doubtless explore and pursue more robust remedies. If green investors become the dominant source of demand in any given trade, such as for a renewable power project, their leverage may mean that high yield- like remedies are inserted into green documents. 11. Regulatory Action: One can imagine in the years ahead that regulators will continue their momentum to codify standards using incentives or disincentives to reinforce — and at times, diverge from — sustainable bond frameworks. We already see increased exploration by global regulatory bodies of subsidies and penalties, and these may come sooner rather than later. One need only look at the discussion in the EU regarding lower capital requirements for Sustainability bonds will likely become a cabinet-level tool to shine a spotlight on a government’s SDG commitments. 7 Sanderson, Owen (2018) “ How to Trust Green Bonds: Blockchain, Climate, and the Institutional Bond Markets ” in Marke, A. Transforming Climate Finance and Green Investment with Blockchains . 8 Hay, John, “ Innogy conundrum challenges green bond market to find its purpose, ” GlobalCapital, June 12, 2018, www.globalcapital.com On the Future of Sustainability Bonds