Sustainability Stars: Martin Scheck and the green bonds of Europe

SAN FRANCISCO (Callaway Climate Insights) — Europe cemented yet another jewel into its sustainability crown when Italy’s government issued the European Union’s biggest-ever green bond in early March, raising more than €8 billion ($9.4 billion) to finance Italy’s green transition strategy and boosting the EU’s status as the world’s fastest growing player in today’s green bond market.

The outsized green debut by Europe’s third largest economy underscored the rising popularity of a sustainability investment strategy that took a back seat in the flurry of social bond issuance in the early days of the pandemic last year. This growing interest is now buoyed by initiatives from the climate-friendly Biden administration, increasingly focused EU regulations and position taking, and the growing number of countries that are making public commitments to net zero emission targets in line with the 2015 Paris Agreement.

Clearly, green bonds, which topped off at $282 billion at the end of 2020 and $266 billion in 2019, are but a fraction of the $128 trillion global bond market. But its trajectory continues to be positive. Forecasts now suggest that investment in green bonds will climb to $400 to $450 billion this year and over the decade, to $1 trillion.

Two factors help explain the increase in the strategy’s popularity and its projected surge. On the one hand, interest has been broadening beyond those environmentally-minded investors who want or are mandated to integrate environmental factors into their portfolios. Sovereigns now are lending their heft to the strategy, especially in Europe and the UK.

Italy’s €8 billion bond issue, while Europe’s largest to date, was only the most recent in an impressive list of European sovereign issues. Rome actually followed Poland, Ireland, Sweden and the Netherlands into the green debt market. Both France with eleven green bonds since 2017 and Germany with two large green bond funds last year, already were heavily engaged. Spain is expected to follow suit later this year, and the UK gave its notice in recent budget documents that London will sell at least £15 billion of green bonds in two offerings over the course of 2021.

On the other hand, confidence is building in the market for green debt service, helped in no small measure by the International Capital Market Association (ICMA). Italy’s bond issue, for example, came to market bearing the imprimatur of ICMA’s Green Bond Principles (GBP) — the signal to investors that the issuers of the bond will spend the funds as advertised. Such assurances are critical to investors’ confidence and by extension, to a well-functioning bond market.

In Italy’s case, the transparency recommended by the GBP reveals that the funding is to be earmarked for environment-related projects that include low-carbon transport, power generation and biodiversity. Authorities also committed to reviewing the framework on a regular basis to ensure compliance with the Principles continues for the duration of the bond.

ICMA CEO Martin Scheck.

ICMA, headquartered in Zurich, Switzerland with offices in London, Paris and Hong Kong and with 600 member institutions in 62 countries, is advantageously positioned as a thought leader across the entire debt capital market representing the whole ecosystem from issuers to investors. The Association’s non-profit mission is to promote resilient, well-functioning international and cross-border debt securities markets because, as ICMA CEO Martin Scheck asserts, markets that are efficient, transparent and fair are essential for sustainable economic growth and development.

It only added its sustainability pillar in 2014 after a handful of international investment bankers asked it to develop and take forward the Green Bond Principles, a voluntary framework for the development and issuance of green bonds.

Today, ICMA serves as secretariat in the administration of the Principles. The external review process is handled largely by independent third parties whose job it is to provide an independent assessment of GBP alignment, namely the eligibility of green projects as well as the commitment to transparency and reporting.

It turns out that the GBP are the common foundation of guidelines now followed in other jurisdictions. For example, they were the starting point of the thinking behind the EU’s ongoing effort to develop the EU Green Bond Standards. The Principles also are the basis of core regulation in Japan where the interest is in a set of standards “with Japanese characteristics.”

And in China, differences that have centered on the extent to which fossil fuels and clean coal can be part of debt offerings, are beginning to give way to a convergence between Chinese guidelines and the international green classifications that the Principles refer to in ways that are positive for climate interests.

Scheck notes that ICMA has been working with China’s bond interests for the last several years, principally with the interbank bond market on facilitating the necessary groundwork for China’s ultimate integration with global bond markets. Obviously the step will require China relaxing certain aspects of its capital controls, but that too is coming, says Scheck.

The influence of the Principles continues to build internationally in parallel with the growing interest in green bonds across jurisdictions, industries and currencies. ICMA estimates that 95% of green bond issuance globally is in line with the Principles. It is because confidence in markets is at the heart of that interest - and that requires getting credible bona fides on behalf of the interests of both the investor and the bond issuer. And that’s what the Principles do.

Wherever green bond guidelines are in place today, those guidelines are probably drawing on ICMA’s Principles. “The Principles are foundational,” says Scheck.

What the unassuming ICMA chief does not say, at least not directly, is that the Principles may very well have become the de facto global standard for green debt disclosure, and that this could help inform a decision that favors a “global baseline” for disclosure of all securities’ green interests. Many hope this will happen sooner rather than later.

For the time being, the anticipation of a universal disclosure standard is in the mix of the debate. Some might say it is overshadowed by the multiple discussions that are underway and influenced by national and regional interests. But not Scheck.

Five years ago, Europe was reaching to establish a framework for harmonizing the characteristics of ESG (the environment, social issues, and governance). Today, Europe is working overtime to put in place systems and regulations that underpin the region’s aggressive green strategies and intentions, Scheck says.

And what is happening in Europe also is part of a larger mosaic.

The good news is that the various interests share a goal, namely that they foster markets that transparently and efficiently reflect legitimate green interests and facilitate their fair pricing.

“I’m confident we will get there,” says Scheck.

Callaway Climate Insights invites each guest featured in this Sustainability Stars column to offer brief comments to three questions focusing on the big picture in sustainability.

Scheck responded to these three questions:

Should we expect regulators and capital market participants to find common ground and agree to a single global standard for disclosure of green attributes of sovereign or corporate bonds?

“The Green Bond Principles have become the de facto global standards and are referenced in the vast majority of green bond issues — they usually form the foundation for regulation in the sector so there is already common ground. Having said that, different jurisdictions move at different speeds and are at different stages with different challenges so we should expect there to be national and regional specificities in disclosure standards.”

How do you and ICMA define risk in the context of green bonds?

“In a narrow sense, in fact, the credit risk of a green bond is the same as the credit risk of a ‘traditional’ bond for each particular entity. One risk that we are focused on is the risk to the integrity of the market — if for example a green bond (or other product) is sold to investors as green but is not in the end used for purposes which benefit the environment — commonly called the risk of greenwashing. The standards set by the Green Bond Principles, including the disclosure requirements and the external reviews, are all designed to build investor trust and maintain market integrity, to mitigate this risk.”

What is the scope of that risk today as you see it?

“For issuers of green bonds the process is very public and the reputational damage which would be caused to an issuer which didn’t “follow the rules” would be very severe — and evidence so far is that the risk is rather limited.”