2018 - 2019 Edition of Citi Perspectives for the Public Sector

Citi Perspectives for the Public Sector |  2018-2019 9 The Realm of the Possible: A Five-Year Outlook While no one has a crystal ball, a rear view mirror analysis is clearly less helpful than an attempt to imagine how this market will develop. The only caveat, before venturing into the realm of the possible, is to say that my views on the green and theme market are biased towards the optimistic. With that said, I predict the below 12 trends will be critical elements of the next five years of bond market evolution. 1. Theme Growth: It is easy to imagine that within five years, the broad-based Sustainability Bond space will mirror that of green bonds in breadth, depth, currency diversity and structural flexibility. At Citi, we are now able to give issuers confidence that they can issue Sustainability Bonds against almost any one of the SDG themes, provided that issuers are willing to work with the market on the expected disclosures and principles. Issuers will likely explore at the board level where they can make their mark and consider aligning theme funding with corporate SDG targets and commitments. While green bonds will still represent the larger portion by far of green and theme paper, as the focus on funding shortfalls across all SDG targets becomes clearer, the theme portion of the sustainability pie will grow. 2. Green Infrastructure: It is similarly not hard to imagine the potential for green to become mandatory in one way or another in the infrastructure funding space, whether for bonds or loans. It does not take much of a leap to get from the Equator Principles, the Green Bond Principles and the recent Green Bond Pledge to an ecosystem that requires all infrastructure funding to meet green standards. While this may seem ambitious over a five-year period, an alignment of a handful of banks and investors could, like with the principles above, jolt the market forward. 6 3. Sovereign Sustainability Bonds: Over the next half decade, as sovereigns move to achieve and disclose SDG targets, sustainability bonds will likely become a cabinet-level tool to shine a spotlight on the government’s SDG commitments. France has been clear about how it thinks about its commitment to the Paris Agreement and the linkages to funding. As the SDGs give thematic flexibility to issuers, sovereigns will pick the flags they want to fly. We should also expect that development banks and sovereigns will guarantee or credit- enhance weaker credit issuers, particularly where they want to encourage the issuer to fund sustainability investments. 4. The Rating Agency Driver: Rating agencies will play a powerful role as they move from incremental disclosure to incorporating sustainability in their rating models as standard practice. In conversations with the rating agencies, there is no doubt that the level playing field of consistent disclosed issuer data has not yet been achieved, at least not sufficiently to make incorporation of sustainability metrics mandatory. However, the pressures in that direction are growing, and in five years it is possible that entire sectors, including financial services, will have robust sustainability disclosures built into rating models. This would in theory mean that (a) the cost of disclosures related to green bond issuance may no longer be incremental; (b) rating agency standards and green standards could increasingly converge; and (c) the market could increasingly differentiate risk — and therefore return — on a green basis, driving a true wedge between pricing of sustainability- compliant and counter-sustainable behavior. 5. Big-Data Kicker: Financial metrics are not the only developing metric that will impact the link between sustainability performance and market funding. Technology such as Internet of Things sensors and big data analytics are being deployed at an astounding pace globally. From water use metrics, pollution controls and monitoring sensors to industrial control systems and precision agriculture tools, the world, and therefore the market, will increasingly have the ability to demand higher-quality sustainability data against which performance can be measured. There is even talk of using blockchain platforms to add immutability, transparency and search functionality, particularly where green bonds are asset backed. Imagine a green bond backed by thousands of solar-powered home mortgages. Or as Owen Sanderson has At Citi, we are now able to give issuers confidence that they can issue Sustainability Bonds against almost any one of the SDG themes, provided that issuers are willing to work with the market on the expected disclosures and principles. 6 Green Bond Pledge, https://www.greenbondpledge.com/