Green gilts to become 'one stop shop' for scheme needs despite 'greenium' and 'greenwashing' fears

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Institutional investor demand for green UK sovereign bonds will be high as pension schemes seek to manage their climate change risks and tap up green opportunities, experts say.

Britain is set to issue a green gilt this year - the first of a series of green sovereign bond issues over the next few years as it seeks to build a green bond yield curve, helping to fund projects to tackle climate change, finance infrastructure, and create green jobs.

Green gilts are seen as a much-needed response to a growing demand for investments that help secure a net-zero carbon future. While there is no set launch date as of yet, something that will depend on market conditions, the government is likely to issue a green gilt around the same time it hosts the 2021 United Nations Climate Change Conference (COP26) to be held in Glasgow from 1 to 12 November.

High pension demand

Quantum Advisory investment consultant Jordon Griffiths said: "I very much feel that green gilts could be in high demand. In fact, when held alongside a wider portfolio, I believe green gilts may be a one stop shop for a range of UK pension scheme needs.

"Specifically, green gilts could help investors or UK pension schemes meet any ESG objectives they have - whether that's a slight ESG tilt or for ESG integration, green gilts can help them manage the portfolio in a way that meets their ESG objectives. And in turn, that helps against climate change risks and other ESG risks such as physical and transitional risk."

Insight Investment head of responsible investment research and stewardship Joshua Kendall said he was "quite confident" the UK's first green gilt will be successful and that the institutional investor market for green gilts will be "substantial".

He said: "We've spoken to clients about the green gilt specifically, and to explain why it's a good opportunity. We believe this is going to be a clear way in which pension schemes will be able to have exposure within their portfolios. We firmly believe that as an institution, we would be in a strong position to have exposure and welcome the opportunity to invest in this green gilt path on behalf of our clients."

Griffiths said there are various advantages to investing in green sovereign bonds. He explained: "It helps with diversification by providing different sources of cash flow to traditional vanilla gilts. Bonds are used by pension schemes to help manage interest rate risk, which is something that green gilts can also do going forward."

Green bonds can be part of a rounded strategy, and is the part of the spectrum of a pension fund's toolkit when they start to think about positive allocations, according to BlueBay Asset Management head of ESG investment My-Linh Ngo.

She said: "First of all, they want to get their head around incorporating ESG risks into what they do, so that's where integration and engagement allows them to do that. When they start to think about positive allocations which are either thematic or impact, I would say that's usually reflective of an asset owner who is further ahead in their thinking and strategy on this."

The challenges

Kendall said there will be uncertainty around how the green gilt will be structured, because it might not always align with every pension scheme's needs, especially regarding the duration of the bond.

"It's also unclear how this bond will be priced but based on what we know today, and if it is going to be issued at relatively similar levels to other gilts, then we think it would be a very attractive opportunity for clients."

There may also be concerns about paying a premium for green bonds over vanilla ones - also known as the ‘greenium', said Griffiths. "There's evidence to suggest that the ‘greenium' doesn't actually exist and that investors aren't paying a premium to invest in green bonds against vanilla bonds - albeit this is very early stages and you could probably find evidence that goes both ways. But I think the general consensus is that there a ‘greenium' doesn't exist."

Greenwashing is another issue, which Griffiths calls "the elephant in the room" in the green bond sector. "Investors need to be sure they know exactly what they are investing in and that the bond is doing exactly what it says on the tin," he said.

UK behind the curve

The UK is late to the table in launching a green gilt; many countries have already issued green sovereign bonds and have also developed corporate green bond markets. Just 1.2% of all global impact bond issuance originated from the UK in 2020, putting Britain in 15th place after Luxembourg, according to Insight Investment's analysis. France was top with 18% market share followed by Germany and the US with 10% each respectively.

Kendall said: "If you go outside of the UK to anywhere in Europe, you've got a great opportunity. And that's where it's much easier for pension schemes to actually align their values with the financial opportunities, because they exist, and they're growing and very much a large part of the investment opportunity. But it just doesn't take place in the UK to the same extent."

Griffiths said green gilts are also a "great opportunity" for the UK government, not just for investors, because they can really help the government to fund the green recovery after Covid-19.

The UK green gilt market is also expected to help grow the country's corporate green bond market. Climate Bonds Initiative co-founder and chief executive Sean Kidney said: "In each country, getting green bond markets going is really helped by liquidity and pricing benefits of sovereign issuance."

If this leads to an substantial increase in the UK's share of green finance, this will create many more investment opportunities for British pension funds.

Sustainable Investment Festival

Professional Pensions' parent Incisive Media has launched a Sustainable Investment Festival to help our readers navigate this rapidly-evolving area of the market.

The Festival will run online from 22-24 June and will include thought-provoking presentations from renowned keynote speakers, innovative breakout events and sessions specifically tailored to meet the information needs of pension consultants, trustees and scheme managers.

During this fully interactive event, our keynote speakers, presenters and panellists will be tackling the big debates shaping the future of sustainable investing, identifying opportunities across asset classes, as well as offering guidance on the fast-changing regulatory environment and best practice when integrating ESG into business processes.

The festival will also look at the latest regulatory requirements for both defined benefit and defined contribution schemes; increasing rules on disclosure, particularly on climate risk; and the growing importance of stewardship in institutional portfolios.

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