When we talk about green bonds, we are not talking about the Green Savings Bond offered by National Savings and Investments (NS&I) where you can invest currently £100 to £100,000 on a three-year fixed rate deal of 1.3%pa, we are talking about lending money to governments for green infrastructure and other related projects.
What is a Government Bond?
Sovereign bonds are where a government needs to borrow money. Professional investors alongside banks, pensions and investment fund manager lend your money to the government for a fixed term mainly at a fixed rate of return or for some, an inflation protected return. At the end of the term, anything between 10 years and 50 years, the government pays back the money it borrowed. These are guaranteed investments, backed by the government. You may have heard the term ‘default’ when governments may not be able to afford to meet their debt interest e.g., when Greece was on the brink of collapse or more recently, Russia, where it is at the risk of default as it struggles to pay its debts given sanctions.
A sovereign bond is known as a Gilt (Gilt Edged Security) in the UK and a Government Bond in other countries. You may have also heard of the term War Bonds, when governments including the UK borrowed money to pay for a war.
Around the world, many countries have committed to net zero carbon emissions by 2050, with some like the UK aiming to be 75% there by 2035. To do this, there must be massive investment in green infrastructure, renewable energy, reduced pollution, energy efficient homes and more. Governments, including the UK, are borrowing ‘green’ money by issuing green bonds to facilitate these changes.
The UK government issued its first green bond in September 2021 and raised £10 billion for green projects. In October, the second green bond issue raised another £6 billion.
The first issue of £10 billion was oversubscribed by 13 times. This means that there was £130 billion already available to be invested in green bonds. The second issue of £6 billion was also oversubscribed by 12 times. Demand is outstripping supply.
Why the Demand?
The Paris Climate Agreement has created a ‘top down’ effect from government to companies to professional investors to consumers. Today, it is not only a requirement that larger firms have a ‘green’ policy and must report on their progress of becoming ever increasingly carbon neutral, it is also the fund managers of your pension and investments funds that must do the same. The office for National Statistics suggested that total private pension wealth in Great Britain was £6.1 trillion March 2018. This is probably nearly £10 trillion now. Add to this, investment wealth, say another £5 trillion at least, we are talking vast, mind-boggling sums.
Now imagine that as a fund manager, you are required to make 75% of your whole investment portfolio ‘green’ by 2035 and 100% green by 2050. Roughly, 40% of all investment funds are invested in Bonds. This is £ trillions to be switched to green. Demand is overwhelming. Already, for the first two issues, demand was c£202 billion. i.e., £0.2 trillion but only £16 billion was issued, that’s just £0.016 trillion of total wealth funds invested in the UK alone of c£15 trillion, all of which will be required eventually to go 'green' and 40% of that invested in 'green' bonds.
Now, multiply this by the numbers of countries that have also signed up to the Paris Climate Agreement. Demand is staggering.
Low supply and high demand drives prices up. There will be two effects to this level of demand when new Green Bond issues start. Firstly, demand will mean governments can borrow ‘green’ money cheaply and demand will also drive capital values of those fixed rate bonds up.
When is the next Issue?
The Government has confirmed that another round of Green Gilt borrowing for £10 billion will be available around the end of 2022/early 2023.
Whilst the issuance of green gilts and bonds will clearly continue, the demand clearly creates opportunity for longer term sustainable investment funds both in the UK and globally for the next 20 or 30 years.