2018 - 2019 Edition of Citi Perspectives for the Public Sector

Citi Perspectives for the Public Sector |  2018-2019 7 We have also just begun to see the emergence of structured Sustainability Bonds. Since Indonesia’s successful February 2018 green sukuk , for which Citi again acted as lead underwriter, the potential to print more green bonds in Islamic formats has been thrown wide open. Similarly, Fannie Mae’s 2017 green securitization is a model for future Sustainable Asset Backed Securities. Sovereigns have only recently begun to participate in the green bond market, after years of being held back by the inability to justify green bond issuance on a cost basis. Citi acted as joint lead manager for France’s fourth green bond, bringing the total French sovereign issuance over the past year to EUR 11 billion. 4 Other sovereigns, from Poland to Nigeria, have also issued green since year-end 2016. But these are still early days. Sovereigns large and small are exploring how to link their nationally determined contributions under the Paris Agreement to green bond issuance strategies. Similar to when Central Banks were first drawn into the financial inclusion dialogue, which exceeded their perceived purview, now sovereign debt management offices are at the first stages of coming to grips with aligning SDG targets to market funding discussions. Setting political factors aside, for sovereigns as for any issuer, the magnitude of institutional funds with sustainability mandates seeking a home makes the demand side of the equation hard to ignore. Yes, $200 billion is still a small fraction of a $7.0 trillion global fixed income market. Yet it seems increasingly likely that more of the global pool of ESG money will find its way to the Sustainability Bond market. Since 2012, ESG funds, or funds across all asset classes with a sustainability parameter, have almost doubled from $13 trillion to over $20 trillion. As Millennials and Generation Z grow into investors, the assets under management by ESG investors are expected to continue to grow also. 5 Nonetheless, $20 trillion is already a gargantuan number. The issue now is how ESG investors find sustainable investment opportunities with size, liquidity and acceptable sustainability metrics. They are begging for qualified product, and issuers are not meeting demand with adequate supply. Challenges and Barriers: Getting to a Trillion Dollars of Issuance One of the most hotly contested issues in the Sustainability Bond space has been and continues to be pricing. Should issuers pay a reduced coupon in return for agreeing to green and theme commitments? Many treasury teams will complain that issuing green or theme provides de minimis financial benefits while incurring significant incremental documentation, disclosure and monitoring costs. So, they ask, why not demand a reduced spread for the sustainability commitments? From a risk-return perspective alone, it is difficult to make the case that a green bond is worth more than a comparable vanilla instrument. Investors struggle to justify pricing the same issuer’s risk differently based only on whether the proceeds are used for green, theme or vanilla purposes. From a pure credit perspective, the risk is the same. Yet, when one looks at this from an aggregate and incremental demand perspective, it is less straightforward. There can be no question that the aggregate demand for the same issuer's security brought green versus vanilla has grown significantly. The early stage of the green bond market was characterized by an important but only marginally incremental dedicated investor base. Green investors were originally viewed as “nice to have,” but within the context of total investor demand, incapable of denting price. Now, however, the largest investors in the world, from a Blackrock to a PIMCO, have investor pools that add materially more buying power and are therefore arguably changing supply-demand dynamics. This is moving the needle for both new issue concessions (NIC) and demand across the curve for sustainability issuers. The Climate Bond Initiative has measured green bond incremental demand by looking at oversubscription levels; green bonds in the USA, for example, are on average three times oversubscribed. While this is an imperfect relative measurement, because U.S. municipal bond deals are often oversubscribed, it is a clear statement of the demand-side surge. 4 Hay, John, “ France grows Green OAT to EUR10.8bn, billions more expected, ” GlobalCapital https://www.globalcapital.com/article/ b17mzc5wrdyrvw/france-grows-green-oat-to-108bn-billions-more-expected 5 Global Sustainable Investment Alliance (2017) “ Global Sustainable Investment Review 2016, ” www.gsi-alliance.org ; Elders, Gregory, et al. “ Sustainable Investing Grows on Pensions, Millennials, ” Bloomberg Professional Services, April 4, 2018 https://www.bloomberg.com/professional/blog/sustainable-investing-grows-pensions-millennials/