Each week, the contours of a green recovery from COVID-19 are becoming clearer. Rather than deflecting commitment to action, the pandemic has shown what happens when a known risk crystallises – providing a live stress test for the devastating impacts of unrestrained climate change.
High-carbon sectors have been hit hard by the global lockdowns, bringing forward the peak in global oil demand, for example. Meeting the UK's 2050 goal of net-zero greenhouse gas emissions is no longer a necessity to be endured but a catalyst for innovation and job creation. As former Bank of England governor Mark Carney put it: "The financial sector is increasingly focused on this opportunity of a lifetime."
COVID-19 has also revealed and exacerbated a range of societal inequalities in terms of income, gender, race, age, and location, underscoring the need for the shift to a green economy to be socially inclusive.
All of this will require unprecedented levels of investment. A net-zero, resilient economy will be more capital-intensive in terms of upfront financing of renewable energy, efficient buildings and transport, as well as nature-based solutions such as flood and coastal defences, sustainable drainage and stormwater retention, restoration of carbon-rich habitats, climate-friendly agriculture and clean water, which in turn will save significant amounts of economic and environmental resources.
In the UK, £400bn will need to be allocated to green infrastructure by 2030, according to PwC. Similarly, UK government figures estimate that meeting 2035 minimum energy-efficiency targets will require a total investment in home upgrades of up to £65bn, an important milestone towards a net-zero carbon building stock.
Banks and investors are now rebooting their strategies and committing to align their portfolios with the net-zero goal. But to achieve this, they need assets that not only meet climate targets but also fulfil social as well as environmental and governance objectives.
As one of the largest asset classes in capital markets, sovereign bonds that support both climate action and social renewal are set to become a cornerstone of sustainable financing. To seize this opportunity, the LSE's Grantham Research Institute, the Green Finance Institute, and the Impact Investing Institute drew up a proposal for the UK government to issue a Green+ Gilt bond, published in October 2020 with backing from leading investors with assets of more than £10tr.
A month later, chancellor Rishi Sunak announced that the UK would respond to growing investor demand and issue its first sovereign green bond in 2021. This is not intended to be a one-off, but rather will initiate a series of new issuances "to tackle climate change, finance much-needed infrastructure investment, and create green jobs across this country".
The green bond market is leading this strategic reallocation of capital, raising finance that is then channelled towards environmental goals. The market has grown rapidly in recent years, with investor demand continuing to outstrip supply.
Total issuance is now around $1tr outstanding since market inception in 2007, from corporations, local and national governments, and development banks; energy, buildings and transport are the 3 biggest areas of investment.
The market is also evolving rapidly into a wider system of sustainable debt, with rising issuance of social bonds as well as new pandemic bonds this year.
But in spite of the City of London's leadership in green finance, the UK remains outside the top 10 in terms of sterling-denominated green bond issuance; the absence to date of a sovereign green bond is one explanation for this underperformance.
"UK government figures estimate that meeting 2035 minimum energy-efficiency targets will require a total investment in home upgrades of up to £65bn, an important milestone towards a net-zero carbon building stock"
So far, 16 countries have issued sovereign green bonds, with 7 others issuing different types of use-of-proceeds bonds – for example, for social spending. France is the largest sovereign bond issuer, raising more than €28bn since starting in 2017. It is also home to the greatest volumes of labelled bond issuance.
Many other European countries are taking part, including Belgium, Germany, Ireland, the Netherlands and Sweden. The EU has also committed to issue €250bn of green bonds to finance its COVID recovery plan.
For the UK, issuing a green gilt offers a way to support public finances in the country's green recovery plan, not only tackling climate change by raising funding for projects in the shift to a resilient, net-zero economy, but also creating green-collar jobs, building skills, and channelling investment across the country into areas of greatest need.
Analysis shows that existing sovereign green bond issuers have secured capital at a cost that is no more than that for conventional non-green issuance and, in a number of cases, achieved tighter pricing and a lower cost of capital for the public finances. Recent issuances in Sweden and Germany were oversubscribed and successfully achieved a 1 basis point discount compared with the conventional non-green equivalent bonds.
Sovereign green bonds can also have a catalytic effect. In Ireland and Belgium, for example, issuing sovereign green bonds helped kick-start broader green bond markets in those respective countries. It is hoped the UK will replicate this success when it issues sovereign green bonds. A more active bond market would help meet growing demand from both retail and institutional investors for high-quality assets that have a positive social and environmental impact.
The proceeds of the UK's green sovereign bond could benefit a range of sectors. The renovation and renewal of building stock would be a critical priority, and the sovereign bond could be used to kick-start a strategic national retrofit programme as well as expanding the construction of energy-efficient, zero-carbon social housing.
There are clear precedents in both the French and Dutch markets for putting sovereign green bond proceeds towards energy efficient building stock. In France, such a bond financed a household income tax credit for energy-saving renovation, a property tax exemption for social housing agencies, and interest-free loans to fund domestic energy efficiency improvements, distributed in partnership with mainstream lending banks.
In the Netherlands, the sovereign green bond channelled money towards energy efficiency in rental housing by providing subsidies to corporations and property owners, and direct investment in improving the sustainability of 45,000 homes.
Careful allocation of the sovereign green bond will enable the government to demonstrate how environmentally sound investments, such as those required to retrofit the built environment, can create high-quality jobs and contribute to rebalancing the UK economy, by targeting deprived areas and communities for example.
The corollary social benefits could be tracked using the Social Bond Principles, which include outcomes such as affordable housing, employment generation, skills development as well as other aspects of socioeconomic advancement.
The government's own ambitions under its recently published 10-point plan include the creation or support of up to 250,000 green jobs by 2030, including an estimated 50,000 through development of greener buildings.
"Sovereign green bonds can also have a catalytic effect"
Following the government's decision to issue the bond, attention is now turning to practical questions about how to fulfil its full potential. This will involve establishing a robust green finance framework that shows how the proceeds will be deployed by the government – including measures to fend off any charges of greenwashing. Strategically, it will also involve identifying how the catalytic effect can be maximised in terms of follow-on issuance both domestically and internationally.
The UK's first sovereign green bond will be issued as the global economy seeks to recover on the back of a COVID vaccine roll-out. It will also be released in the year when the UK chairs the G7 group of industrialised nations, as well as the COP26 climate summit next November.
The UK green sovereign bond could form part of a coordinated effort by governments across the world to issue similar instruments that aim to make the green and inclusive recovery a reality.
Related competencies include: Sustainability