Two weeks before the UK’s prime minister announced plans to sell hundreds of new licenses to drill for oil in the North Sea, the government issued a green bond.
The July transaction raised £2bn, adding to £26bn already issued through green Gilts.
But the political decision to ‘max out’ Britain’s fossil fuel potential has left investors in that green Gilt programme wide open to accusations of greenwashing.
When the UK first tapped the market in 2021, it had a world-leading net zero commitment. Since then, as well as the drilling licenses, the government has approved a new coal mine, weakened the carbon market and challenged rules to clamp down on traffic emissions in London.
Bu the UK is not the only sovereign green bond issuer to backtrack on its climate commitments.
Sweden tapped the market in 2020, but earlier this year – after less than six months under a new government – the Swedish Climate Policy Council found that emissions were on the rise for the first time in 20 years.
“The political cycle drives much higher volatility for sovereign green bonds than corporate ones when it comes to climate credibility,” said Ulf Erlandsson, founder of the Anthropocene Fixed-Income Institute, a Stockholm-based green finance think tank.
Downgrades but no divestment
IPE was unable to find any green investors who sold their bonds as a result of UK or Sweden back-pedaling. Nor have any publicly stated they won’t buy more in the future (the UK’s next sale of green Gilts is slated for next month).
Insight Investment downgraded its in-house rating for the UK’s green Gilts in December.
The £683bn London-based asset manager assigns a ‘dark green’, ‘light green’ or ‘red’ label to environmental and social bonds, by assessing both the governance of the bond itself and the issuer’s broader credibility.
David McNeil, Insight’s head of responsible investment research, said the decision to downgrade the UK from dark to light green was influenced by the slow implementation of net zero policies and lack of impact reporting on the green Gilts: the government promised to publish an explanation of the environmental benefits financed by the deal, but so far it hasn’t.
“All that started to call into question the credibility of the national transition strategy and its link with the green Gilts,” McNeil explained. Insight still holds the notes, but “downgrading them was a way of making it clear that we’re tracking these issues” he said.
The Debt Management Office (DMO) told IPE it plans to publish its first impact report by the end of September, as stated in the Government’s 2023 green finance strategy, and will publish biennially thereafter.
Possible solutions
Carmen Nuzzo, professor in practice at the Grantham Research Institute on Climate Change and the Environment and former head of fixed income at the Principles for Responsible Investment (PRI), argued that it’s down to investors to undertake adequate due diligence on a sovereign issuer before buying a green bond, to reduce the chance that they’ll be left holding notes linked to accusations of greenwashing.
“Investors shouldn’t be buying bonds just because they have a green label, no questions asked,” she said.
Nuzzo is currently helping to develop Ascor, short for “assessing sovereign climate-related opportunities and risks”, which will give investors access to what she describes as “an assessment that allows them to slice, dice and compare data to work out whether sovereigns plans are credible, what the climate risks are, and where they need to engage”.
The hope is that standardised data will make the due diligence process more robust when it comes to evaluating how serious a government is about the climate transition.
Ascor will publish analysis for the first 25 countries in December.
Although the project is focused on mainstream government debt, Insight’s McNeil said it will provide “big benefits” for green bond investors, too. He believes engaging with debt management offices before a deal comes to market is key to getting them to understand the link between individual transactions and broader, credible green strategies.
But Erlandsson said the reality is that investors have limited leverage over sovereigns.
The solution, he believes, is to invest in sustainability-linked bonds (SLB): unlike ‘use-of-proceeds’ bonds, which require upfront commitments about where the money will be spent, SLB proceeds can be spent on anything, but the coupon is tied to achieving or failing to achieve certain environmental and social objectives.
“Those longer-term incentives mean investors don’t have to just close their eyes and hope the next person who get into power with do the right thing,” he said.
The step-up levels on SLBs are currently negligible, though, so the incentives remain minimal when competing with political pressure and other factors.
There are also ‘green covenants’, added Erlandsson: “When investors buy high-yield corporate bonds, they put clauses in the contracts to protect them from some of the governance-related volatility risk they don’t get from other types of deals.”
Perhaps investors should introduce the same safeguards for green government debt, he suggested.
“Sovereigns are volatile too: there are situations where they renege on climate commitments because it’s electorally opportunistic, even if not economically rational. Investors need to protect themselves from that.”
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