Green is not the new black; it is here to stay

April 12, 2021 09:04
Photo: Reuters

A global, public health crisis; social inequality and unrest; record economic retraction and violent swings in financial markets. To say that 2020 was a very challenging year might be the mother of all understatements. The primary driver for the turbulence in fixed-income markets was, to state the obvious, the Covid-19 pandemic and its associated effects on society and the economy. As credit investors, typically we would have some miserable, lugubrious take on such market events. Although there certainly will be a reversion to that base-case disposition sometime in the future, we actually see a silver lining in all of this.

If nothing else, the Covid-19 pandemic exposed the importance of addressing environmental and social challenges. Within investments, “sustainability” came under the spotlight, drawing attention from all corners of the capital markets. In fact, when we zoom into 2020, it turned out to be a record fundraising year for sustainable investment funds, with global net assets reaching close to US$1.6 trillion. It was also a record year for green and sustainability-themed bonds and loans with issuance of US$700 billion for an 80% jump year-on-year.

Of course, sustainable investment funds were already experiencing significant growth before the onset of the pandemic: between 2016 and 2019, sustainable assets almost doubled. This growth was driven by allocations from European asset owners, as a wave of regulation that comes into force this year created a catalyst for institutional investors to invest sustainably. At the same time, in the wholesale market, private banks and wealth managers have also started to create sustainable investment propositions.

However, in 2020, with secular winds behind it, sustainable finance shifted from a niche corner of the market to a position of prominence and permanence. Sustainable finance has gained momentum, scale and, for various reasons, there is no turning back. While the forces behind the growth of sustainable finance have been strengthening for years, the effects of Covid-19 on the market, governments, regulators, investors and companies have all proved to be the catalyst for its indelibility. In addition, we argue that in some ways, 2020 was a dress rehearsal for what the effects of climate change could wreak on society, the economy and financial markets.

As we happily turn our backs on 2020 and look ahead to 2021, we see only rapid growth and wider development in the trajectory of sustainable fixed income. As much as 30% of the new seven-year €1.1 trillion European Union (EU) budget and €750 billion recovery plan will be spent on fighting climate change. That is by far the highest share of dedicated spending for “green” purposes an EU budget has ever made. Financing that with some €225 billion of green bonds will have a profound effect on the €650 billion green-bond market and green-debt finance in general.

And this is all before we examine the so-called “blue” wave in the United States, where Democrats now have a slim majority government. Indeed, President Biden – who moved to reinstate the US to the Paris climate agreement just hours after being sworn in as president – has made financing a green recovery from the pandemic a central plank in his platform. He plans for nearly $7 trillion in his climate and environmental justice proposal.

Then there is China, the world’s largest emitter of greenhouse gases at over 10 gigatonnes (GT) of CO2 (compared to the US, which holds the number two spot at 5.4GT). China now promises to hit peak emissions in 2030 and reach net zero by 2060. That is a pretty big “paper promise”, which will need some concrete progress before its credulity can be assured; the same can be said for Biden in the US, we would add.

Assuming this happens, according to Climate Action Tracker, 63% of global emissions will be covered by these targets, making the goals of the Paris Agreement seem more achievable with global warming of 2°C now likely by the end of the century compared to the 3.5°C temperature pathway predicted in 2009. Whether as a reaction to expected policy change, or because of mounting pressure from the public or financial stakeholders, many companies are also following suit by setting their own science-based targets to reduce carbon emissions.

From all of these efforts we can clearly deduct that there is no going back on the green transition. The prospects of investing in a secular trend that is underwritten — at least in part — by government provides confidence that the trend will continue along its path, likely at an accelerated rate. Overtime, we expect the EU budget will likely trigger more supply of sustainability-themed debt issuance. In turn, this will create a deeper, more developed and more liquid sustainability themed debt market and provide great opportunities to finance positive change. Green is not the new black; it is here to stay.

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Andrew Jackson is Head of Fixed Income, and Mitch Reznick is Head of Sustainable Fixed Income, at the international business of Federated Hermes.