The Chancellor's Budget has provided more detail on the UK government's plans to issue green bonds in 2021, which are expected to be first issued in Q3 this year.
Below, Robert Gall, Head of Market Strategy at Insight Investment, answers some common questions we have received as investors consider the suitability of these assets for their portfolio.
When can investors expect to see the first issuance of green gilts?
From the budget announcements and our meetings with the Debt Management Office (DMO) our understanding is that we should expect details of the Green Gilt framework in June. This will provide more detail on categories of projects that will be eligible under the Green Gilt programme and other practical details, e.g. what happens to investors' money before it is invested to ensure it is not mixed with non-green gilt money. We expect the framework to be aligned with the International Capital Markets Association’s Green Bond Principles.
Furthermore, we expect the first issuance in Q3, probably around August, with a second issuance by December. There will be a minimum of £15bn of issuance and possibly more as the DMO has an unallocated remit of £28bn.
How will the issuance of green gilts impact perceptions of conventional gilts?
Theoretically there will now be three types of gilt. Firstly, old gilt issuance whose proceeds could have been used for green and non-green purposes. Secondly, new green gilt issuance and lastly new issuance which is not green. Potentially the market might differentiate between all three, but initially the issuance of green gilts will be relatively small, so this delineation is likely to be between green gilts and other gilts
Will the covenant for green gilts match that of ordinary gilts?
Yes, we expect a green gilt to look like any other gilt: the same Bloomberg ticker, the same credit risk, eligible for use in a futures contract and for use in the repo market. This is the model that has been used in most other European markets.
If green gilts have the same credit quality as ordinary gilts but have a lower yield, why invest in them?
There is much discussion around fiduciary responsibility involving more than just financial returns these days. However, broadly speaking many investors agree fiduciary duty covers management of both financial and non-financial risks, including ESG factors. So, for investors, assessing the broader environmental or social impact of their investment activities is a critical determinant; as such, some are prepared to accept a marginally lower yield to know their investment will have a positive environmental and/or social impact. This is clearly the case in European government bond markets where green bonds typically trade at a premium price (lower yield) to their non-green alternatives.
The UK government’s focus on climate change is bringing sharper focus on this issue for many investors including UK pension schemes, the largest of which will be required by law to begin implementing climate change governance measures and to report on them from October.
How might green gilts be embedded in client LDI portfolios?
This question needs to be discussed with clients on a case-by-case basis. Also, different investment consultants will recommend different courses of action for their clients.
When might we see the launch of a pooled green gilt fund?
To have a green gilt fund, you would need nominal and index-linked green gilt issuance across the curve. This is going to take quite a few years to build out – so pooled funds are a possibility but some way in the future. We will continue to monitor developments closely.
Green gilts may help pension schemes achieve their broader environmental objectives while investing prudently to reach their financial targets.
If you would like to find out more, please contact your usual Insight contact.
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