The Green Bond Revolution

Wealth DFM talks to Blackrock’s Cara Milton-Edwards about why green bonds are becoming increasingly popular as an investment vehicle in the ESG space

WEALTH DFM: IN YOUR ROLE AS A FIXED INCOME PRODUCT STRATEGIST COVERING SUSTAINABLE INVESTING, IN WHICH AREAS ARE YOU SEEING THE MOST INTEREST FROM CLIENTS AT THE MOMENT?

CME: I'm in a very privileged position where I talk to many investors about the range of fixed income solutions at BlackRock that incorporate sustainable outcomes. Of those conversations, one of the most regularly touched upon topics is green bonds. This is both from the perspective of how much the market has grown, but also the increased investor demand that we see for this asset class.

In terms of the market growth, if we look back to 2015, this was a market that had just $225 billion dollars of outstanding debt. At the end of 2020, that had grown to over a trillion dollars. We've seen huge growth in the market. However, alongside the size of the market, we've also seen an increase in the diversity of issuers. I think that is really what has piqued investors’ interest. Ultimately the conversations become about what role can green bonds play within my portfolio.

WEALTH DFM: WHAT ARE THE DEFINING PRINCIPLES OF A GREEN BOND?

CME: In some ways it's easier to start by looking at what a green bond isn’t.

A green bond isn't a bond issued by a green company. A green bond is a financial instrument whose proceeds are exclusively applied to new or existing projects with environmental benefits. When a green bond comes to market through primary issuance, there are four characteristics that have become the market standard. These are known as the Green Bond Principles.

These principles are: Use of proceeds: at initial issuance, understanding exactly what that green bond will be funding and ensuring that those projects fall within what are known as the Green Bond Principles’ eligible categories.

The second is that there has been a process for project selection and that there are clear, environmental, sustainable objectives of those projects.

The third is on reporting. The expectation is that all green bonds will report on an annual basis on the projects funded. Also there should be metrics available as to the environmental benefits that result from projects funded.

Finally, proceeds from the bonds should be separate - they should be ring fenced from other assets on the balance sheet and verified by a third party or an auditor. At Blackrock, we've been part of this Green Bond Principle executive committee since 2014. These have become the principles that have set the standard in the market, but they also shape the market for the future. We've seen changes and we've seen them develop throughout time.

WEALTH DFM: SO WHY NOW FOR GREEN BONDS IN INVESTORS’ PORTFOLIOS? WHAT ARE THE BENEFITS WHICH THESE GREEN BONDS CAN OFFER?

CME: We've come such a long way from 2007, when the first green bond was issued by the European Investment Bank. With the market becoming much larger and with growth in the diversity of issuers too, that has really changed the role that green bonds can play within an investor's portfolio.

I see it from two perspectives: The first is from the perspective of the fixed income characteristics the green bonds can offer a portfolio. The second is from the perspective of the environmental characteristics.

We've come such a long way from 2007, when the first green bond was issued by the European Investment Bank

Firstly, from a fixed income perspective, two characteristics stand out. One - if we look at broad green bond market exposures. For example, the index that is tracked by our iShares Green Bond Index Fund is the Bloomberg, Barclays MSCI Global Green Bond Index. This offers investors an average credit quality of A+. That is an increase on the average credit quality that you might get compared to a non-green, broad aggregate index. The increase in credit quality comes from exposure to higher quality issuers such as multilateral development banks and governmentbacked agencies.

The second is from a performance perspective. Sustainable indexed fixed income offers investors greater resilience during periods of risk off and that resilience is driven by fixed income factors.

We see some of those same characteristics in these broad green bond market exposures. For example, last year during periods of volatility, and over the course of 2020, the Bloomberg Barclays Global Green Bond Index outperformed the Bloomberg Barclays Global Aggregate Index.

This outperformance did not come from the fact that green bonds outperformed non- green bonds. On a bond by bond basis, we see green bonds perform in line with their non-green equivalents. Instead, that outperformance came from the sector differences in broad green bond exposures in comparison to those non-green universes.

From an environmental perspective, there are positive implications when an issuer comes to market with green bonds, for example, it could be indicative of an issuer looking to align themselves with net zero in the future. Many investors that we talk to are increasingly looking to incorporate climate risk considerations into their portfolios.

From that perspective, a green bond investment helps mitigate some of those climate risks. That can be achieved and seen through the impact reporting which is part of the Green Bond Principles that every green bond issue reports annually on environmental metrics from projects funded.

The difficulty for investors is how do I aggregate my overall impact when I'm holding multiple green bonds? This is because green bonds will report on different metrics, and they do not report at the same time or in the same way. At Blackrock, we've worked very hard to create a portfolio level impact report and were first in market to do this for the iShares Green Bond Index Fund. This allows investors to quantify the positive environmental metrics that come from an investment in green bonds.

WEALTH DFM: TO CONCLUDE, WHAT WOULD YOU SAY ARE THE KEY TAKEAWAYS FOR THOSE WHO MIGHT BE LOOKING AT GREEN BONDS AS AN INVESTMENT VEHICLE?

CME: The growth that we're seeing in the market and the increase in the diversity of issuers is giving investors huge confidence in the market. From our perspective, the role of indexing within the development of this market has been key in terms of providing investors with that transparency and standardisation.

That gives investors more confidence in terms of capturing that growth. But it has to go hand in hand with investment expertise in this asset class. BlackRock its own proprietary analysis applied to every green bond that comes to market.

Finally, if there is a role for green bonds within investor’s portfolios, being able to quantify the impact and the positive environmental benefits is important. That is achieved in iShares products, through the impact reporting. and provides transparency as to the role, from a sustainable perspective, this asset class could have within a portfolio.

The growth that we're seeing in the market and the increase in the diversity of issuers is giving investors huge confidence in the market

ABOUT CARA MILTON-EDWARDS, FIXED INCOME PRODUCT STRATEGIST, ISHARES EMEA

Cara Milton-Edwards is a product strategist covering fixed income ETFs. Cara is part of the team responsible for supporting client engagement, creating thought leadership on fixed income markets and fixed income ETFs, and working to develop new fixed income ETF products. She specialises in wealth and retail client conversations.