Green Bonds

A Huge New Opportunity

The sovereign green bond market is now offering investors more opportunities for impact as they restructure their portfolios to pursue net zero strategies.

On 8 July 2021, Lyxor ETF hosted a webcast on sovereign green bonds with Sean Kidney, CEO and co-founder of Climate Bonds Initiative, alongside Lyxor’s François Millet, Head of ETF Strategy, ESG & Innovation, and Philippe Baché, Head of Fixed Income Product. Below are a few edited highlights from the webcast which you can listen to in full here.

Sean, what are the most interesting developments in the sovereign bond market in the past few years?

Sean Kidney: The most interesting development is that there is a sovereign bond market! A few years ago: nada, zip, nothing. It took the French government deciding to issue sovereign bonds before we saw any action. This started a bit of an arms race for sovereign bonds. The Polish government decided to pip them at the post, quickly issuing the first sovereign green bond while the French were still organising their programme. The Agence France Trésor [the agency responsible for managing France’s debt and cash position] came to market in a studied and careful way, and France now has by far the largest global green sovereign market, with around €40 billion of issuance. That said, we’ve seen a lot of others come to market.

The broader green bond market is exploding too. It will have some 80% growth this year alone, and will soon have €2 trillion outstanding. That sounds like a lot, but there’s a €100 trillion bond market, so there’s still a long way to go. The space we really have to grow into is sovereign bonds: there’s about €55 trillion of those and only around €120 billion of that figure is green bonds. That means the growth opportunity is in the sovereign space. It’s a late starter in the past few years ago, but now we’re seeing issuance everywhere around the world.

What can you tell us about the role of individual governments in green bond issuance?

SK: I’ve already talked about the French government. Full credit to them: they’ve been fleshing out a yield curve and doing demonstration issuance and discovered, much to their surprise, that they can reap rewards for the French treasury.

Each government treasury around the world has a similar approach. There’s the benefits to grow the private green bond market, ‘pour encourager les autres’ if you like, and there are the benefits to their own scheme of signalling what the government is doing for investors, increasing investor engagement and telling citizens about the work they’re doing. When the Dutch government issued their green bond, where most of the proceeds went to coastal protection – you thought ‘ah, that makes a lot of sense’. It was fantastic they did that and drew attention to the work they’re doing.

François, what factors do you think explain the huge increase in issuance and investment? Is there a genuine drive towards net zero?

François Millet: It all starts with the role of green bonds in a portfolio. Sovereign bonds make up around 54% of a typical global aggregate index. Yet until 2016, there was absolutely zero in terms of green sovereign bonds for portfolio allocation. That was the gap, the missing link which has now been repaired. And there has been a rapid growth of the market, especially in the last two years. We’re not talking about France alone anymore, but a market where 30% of the outstanding sovereign green sovereign bonds have been issued this year.

That’s an amazing stat. Six months ago we couldn’t even have launched our new sovereign green bond ETF because it wouldn’t have met the diversification ratio needed in UCITS ETF regulation. Now we’re comfortable with that, thanks to the multiplication of issuers.

Any investor should have a green bond strategy because all the building blocks are there to do it now. The liquid and diversified aspect for sovereign bonds was missing, but that’s not the case anymore. That’s why we’ve seen the market almost double in size in about one year.

From an investor’s perspective, what’s going on in the change of attitude of investors?

FM: I think the change comes from two areas: first, portfolio objectives are changing. On top of the return-seeking objectives and ESG criteria, investors are increasingly looking to align their portfolios – committing to a certain warming scenario with no or limited overshoot, for example. This is a different concept. More investors are committing to net zero and showing that they are restructuring portfolios to meet this alignment target.

The second change of attitude is that there is an ever-growing request for traceability. Green bonds that provide info on use of proceeds but also report impact are essential, because investors want to know not only how climate change impacts the portfolio, but how the portfolio impacts climate change. Now they look for impact metrics, and are pushed that way by regulation too.

Philippe, what has been Lyxor’s response to these developments in terms of product? What does Lyxor bring to its clients?

Philippe Baché: Our current range has three different options for taking a position on green bonds. First, there’s our pioneering product, the first green bond ETF launched in 2017 which now totals more than €570 million in assets. This is an aggregate product because it combines exposure to sovereigns, quasi-sovereigns and corporates. Second, another aggregate green bond ETF, this time with an additional ESG screen which excludes some controversial activities as well.

And third, the new product that we launched at the start of July. This trades under the ticker ERTH and it’s specifically dedicated to sovereign issuers in the eurozone, to help support investors’ net zero carbon objectives and to perform several potential roles in a portfolio as it has several quite interesting characteristics.

ERTH can be used as an investment tool for a net zero strategy adapted to the government bond exposure of a fixed income portfolio. Given the long-term nature of the green bond market, the rates exposure of this portfolio will be greater than the rates exposure of a standard government bond exposure. And maybe most interesting, thinking about what François said earlier, it offers dedicated use-of-proceeds reporting, and traceability in the sovereign bond market.

Watch the full replay to hear more from each of our speakers, or learn more about Green Bond ETFs.

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