La Française: Will green bonds be enough to meet carbon reduction targets?

October 7, 2021

By Gaël Binot and Hervé Chatot, respectively Emerging Markets Fixed Income Manager and Cross Asset Manager, La Française AM

At the end of 2020, the European Union decided to revise its environmental objectives upwards by targeting a 55% reduction in greenhouse gases by 2030 compared to 1990 levels, replacing the previous target of 40%. This new objective, "in line with the Paris agreement to contain the temperature rise well below 2°C" has led to a firmer commitment from EU Member States to accelerate investment in the green transition to fight against the negative impact of climate change.

A third of the €750 billion NextGenerationEU (NGEU) European recovery plan will be used to finance environmental projects by 2026. To achieve this target, the European Commission will issue €250 billion in green bonds over the next five years, thereby becoming the largest issuer of green bonds. European Commissioner Valdis Dombrovskis said that " “Europe will need around €350 billion euros of annual extra investment to meet its 2030 emissions target in energy systems alone.”

The EU is developing a set of regulatory measures to ensure market transparency and guide investors towards genuine green investments.

In Europe, pending the future European standard (taxonomy) on green emissions which will not be available for at least a year, the first European green issuances will be based on current market practices. These practices are based on the voluntary standard of the International Capital Market Association (ICMA) and its four principles ("Green Bond Principles"): use of proceeds, process for evaluation and selection, management of proceeds and reporting. The purpose of this regulation is to ensure market transparency to guide investors towards truly green investments.

At the end of 2020, the total stock of green bonds issued by States was $88bn globally and $77bn in Europe. However, the size of this market is still relatively insignificant in comparison with the total amount of global and European sovereign issues. Nevertheless, to achieve the States' objectives in terms of the decarbonisation of economies, the investment needs of energy-related infrastructure are immense. The International Renewable Energy Agency (IRENA) estimated that $110 trillion will be needed between 2016 and 2050 to achieve a low carbon energy system.The financing of these needs makes green bonds a booming market with strong potential for growth.

In Spain, on the basis of the “Green Bond Framework”, the Spanish Treasury has identified an envelope of €13.6 billion in green government spending over the 2018-2021 period. On 7 September, Spain launched its first green bond for 5 billion euros repayable in July 2042, thereby joining ten other EU countries that have issued green bonds: France, Germany, the Netherlands, Belgium, Ireland, Sweden, Poland, Hungary, Lithuania and more recently Italy (€8.5 billion in March 2021).

This first Spanish green issue was a success, drawing more than 60 billion euros from investors. The annual return in euros was 1.034 %. After this first Spanish issue, Germany also launched a new green bond with an issue volume of €3.5 billion on 8 September, maturing in August 2031. The growing interest of investors is reflected in the green premium - a "Greenium" - of 4.4 bp compared to the traditional bond with the same maturity, issued a few months earlier.

The European Commission has announced the first green issue of the €250 billion programme for the month of October. The size of the EU's green issues will make Europe a world leader in sustainable finance. This first issue is also an initial step in the construction of a green yield curve which will serve as a benchmark in the future for green issues in euros by European States.

The future needs for green financing, the commitment of the European executive to earmarking funds for projects linked to climate change and recent investor appetite for European green issues all suggest that there will be a demand for this initial issue.

A number of other States will be issuing green, social and sustainable bonds over the coming years. It will be essential to be able to verify the allocation of funds to environmental and sustainable projects, etc., through a binding international standard. However, to achieve the carbon emission reduction targets for 2030 and 2050 and to change the energy mix of countries, issuing green bonds alone will not be enough. The EU's flagship climate project, the European Emission Trading Scheme - EU ETS, must help investment flows into taxonomically aligned activities and accelerate change in all the sectors concerned.