Despite the green bond market treading water in 2018, BBVA is bullish about the market's prospects in 2019 – driven by an emerging green premium, rating agency engagement, and a light touch from Europe's regulators. Its green bond specialists talk to Environmental Finance
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Environmental Finance: Despite green bond issuance levelling off in 2018, BBVA is forecasting a return to strong growth in 2019. What’s behind the bullish forecast?
Agustin Martin, Head of European Credit Research: There has been a combination of factors that explain why issuance in 2018 has been broadly flat. There has been a decline in green bond activity among big Chinese issuers, and there has been a decline in issuance from the largest issuer of green mortgage-backed securities, the US agency Fannie Mae.
In addition, there have also been a number of qualitative factors, such as the ongoing development of the EU’s sustainable finance taxonomy and its planned green bond standards [which have encouraged some issuers to delay launching green bonds.] In addition, overall global bond issuance this year has declined compared with 2017.
But I see it as a temporary pause. Our forecast is that issuance [in 2019] will reach $220 billion, back to the 30% year-on-year increases we’ve seen in the recent past. We expect to see more sovereigns coming to the market, such as the Netherlands, but we also expect that more complicated conditions in financial markets will encourage green bond issuance.
When yields were very low, there was very little benefit in spreads or secondary market performance from issuing green versus conventional bonds. From this year, however, we expect to see the famous green premium, in both primary and secondary markets, making ESG bond issuance very interesting.
This is because ESG bonds tend to be more oversubscribed than their conventional equivalents. This has not had a big impact on price, given the effects of the European Central Bank purchase programme. But we saw some evidence of how this might change. In the recent turmoil in the Italian markets, some green bonds issued by Italian financials and corporates performed better than conventional bonds.
We expect to have finally the first quantitative evidence of green premiums in primary and secondary green bonds – this is what underpins our forecast for next year.
EF: What about market infrastructure? Are there any missing parts that could help kickstart the market?
AM: The prime thing for us is the greater participation of the credit rating agencies. Moody’s and Standard & Poor’s are doing work to develop more systematic tools to help issuers and investors better understand how their ESG credentials stand up.
In the past, this has been somewhat ad hoc and unstandardised. They are now developing issuer-level systematic tools that will allow participants a better understanding of these ESG credentials. It will really help the market infrastructure.
In addition, the fixed income markets are very conservative. Investors are familiar with the big credit rating agencies, but they are still getting used to the secondopinion providers that have dominated ESG scoring in the green bond markets. We think that increased focus by the rating agencies on the ESG markets, and the provision of proper ESG scoring, will be an important factor to drive growth.
EF: Do you expect the proposed EU green bond standard to help or hinder the market’s growth?
AM: We are quite positive about progress so far and about the conversations that are taking place. It is clear that the EU’s standard will be based on current market practice. As we’ve seen with the European Commission’s progress report, the main components will be use of proceeds, a process for project allocation and evaluation, tracking of allocation, and pre- and post-issuance reports. From that point of view, we’re positive we’re not seeing anything disruptive or that goes against what has been successful in the green bond market.
There are certain areas where we’d like to see some clarity. For example, the EU is proposing that external review verifiers will need to be accredited by some type of supervisory body – the Commission is due to provide guidance on this. In addition, non-EU domiciled entities will be eligible to apply the EU green bond standards. The most important point is that the EU standards will align with the Green Bond Principles: compliance will be voluntary, and currently existing bonds that meet the provisions of Green Bond Principles will also be compliant with the EU’s proposed standard. We don’t see any risk of anything disruptive taking place.
EF: The EU’s initiative is designed, in part, to reassure investors that they are getting what they are paying for when it comes to sustainable financial products. What advice do you give to institutional investors interested in getting involved in the green bond market?
Patricia Cuenllas, DCM, Sustainable Bond Group: It’s important to learn about the issuing companies and their strategies, and not just rely on the green reports that the various second-opinion providers produce: you need to form you own view. One of the key characteristics of green bonds is transparency, and there are various certification mechanisms that have also evolved along with the market that allow a great level of comfort. Issuers are committed to this transparency and do tend to think very carefully about the projects they select to fund with green bond proceeds, and about the reports they publish, which tend to be audited.
What we usually see when we visit investors is that, in addition to the portfolio manager, there will also be an ESG expert, and they will both have a say, and will both have to agree on a particular investment.
EF: What developments you expect to see in the green bond market in 2019?
PC: Sovereigns, renewable energy, the building sector and transport are likely to continue to be some of the bigger contributors to the green bond market. However, given the need to build out the low-carbon economy, we are seeing companies from all sectors integrating environmental drivers into their corporate and financial strategies. For example, we’ve seen [Spanish telecoms giant] Telefónica publish its SDG framework, and we expect to see big food companies play an increasing role in terms of issuing green bonds.
Angel Tejada, DCM, Sustainable Bond Group: Investors are very keen to see this sort of diversification. Similarly, I would like to see packaging, industrial and manufacturing companies getting involved to use green bonds to fund sustainability initiatives. The circular economy will be very important, and I’d like to see corporates using it as a motivation to issue green bonds. We also expect that issuers that have been active in one ESG pillar will get involved in other pillars, by issuing social bonds, or gender bonds, for example.
However, while we are of course very happy to see innovation, it’s important that big players come back to the market with repeat issuances, and grow the market in different jurisdictions.
AM: We certainly expect to see more growth in the green asset-based finance space, particularly covered bonds and securitisations. We are particularly supportive of the energy efficient mortgage initiative led by the European Mortgage Federation, which should incentivise financial issuers to mobilise the green assets on their balance sheets to tap the market with green-backed bonds, and of efforts of countries like Luxembourg, which is developing regulations governing covered bonds supported solely by green assets.
The growth of green securitisation depends, however, on how European issuers deal with the new securitisation regulations, which are quite complex. We expect to see more green corporate securitisation which, in Europe more so than the US, is quite an exotic market.
We believe this is a likely source of growth: we expect to see a lot of demand from investors when they see that those structures are 100% supported by green assets. This is a step forward beyond the traditional use-of-proceeds green bond, where you have monitor the issuer, etc. By issuing green bonds directly to finance ring-fenced green assets, issuers can address concerns about additionality and green washing.
EF: What about the green loan market? What are your expectations there?
AT: The publication in 2018 of the Green Loan Principles was a milestone for that part of the market, and we expect to see a growth dynamic similar to that of green bonds. It’s worth highlighting the potential higher degree of innovation with loans compared to bonds, mainly because of the bilateral relationship between corporate borrowers and financial institutions – we’ve seen ESG revolving credit facilities offered, and loans linked to companies’ ESG performance.
The development of that part of the market means we have a wider range of ESG debt products we can offer to clients, and we think that the growth of green loan provision will support increased interest in green bond issuance, as corporates graduate from green loans to fully-fledged bond issues.
PC: Generally speaking, we expect the green bond market to continue its growth trajectory in 2019, not only in volumes but also in terms of different kinds of issuers, sectors and investors coming to the market. Green bonds are increasingly mainstream – it’s no longer a niche market.
BBVA taps green bond market
For BBVA, the green bond market is more than a means of helping its clients raise finance – it is also a source of its own capital. In May 2018, the bank issued its inaugural green bond, €1 billion of seven-year non-preferred senior paper, the largest green bond from a Eurozone financial institution. Strong demand – with €3 billion of orders taken in just three hours – allowed BBVA to shave 15 basis points (bps) off the price, from 95bps above mid-swap to 80bps above.
“Demand from ESG investors for debt from financial institutions will be increasingly important in the years to come,” says Tejada. Socially responsible investors accounted for more than 51% of BBVA’s inaugural green bond, he adds.
The bond was placed weeks after BBVA published its Sustainable Development Goals (SDG) bond framework, which sets out a taxonomy of project types that can be financed by green, social or sustainable bonds issued by the bank. The BBVA SDG Bond Framework won the Best Designed Green/SRI Debt Framework in the Global Capital SRI Awards 2018.
In addition, the inaugural bond issue required more than a year of planning, with the bank putting together marketleading governance and oversight processes to enable ongoing sustainable bonds issuance.
The BBVA group followed this bond with two other green bond market firsts: In June, BBVA subsidiary Garanti issued the first private sector gender bond and, in September, BBVA Bancomer sold the first green bond from a Mexican private bank.
After starting this process in 2018, returning to the ESG bond market will be part of BBVA’s 2019 funding strategy. The bank’s intention is issue a benchmark bond – whether green, social or sustainable – on an annual basis.
“This market will be important for the bank in the context of BBVA’s 2025 pledge, announced in February 2018, under which the bank committed to mobilise €100 billion by 2025 to tackle climate change and promote sustainable development”, says Tejada.
“The 2025 pledge is organised around three main pillars. The first, Finance, includes green finance, sustainable infrastructure, social entrepreneurship and financial inclusion,” he says. “Under the second pillar, Manage, we are committing to work to mitigate our own environmental and social risks and minimise potentially negative impacts, both direct and indirect. The third, Engage, will see BBVA engage all stakeholders to increase the financial sector’s contribution to sustainable development.”
BBVA’s active participation in the green bond market has helped raise the profile of the bank and bring it new business opportunities, he adds: “A pioneer role in this asset class has allowed us to be present in new geographies where we took leading roles in landmark deals.”