When it comes to ‘green gilts’, we believe a balanced approach is the best way to understand how these assets could fit into portfolios and where, as investors, we need additional comfort about the ‘impact’ and ‘additionality’ that these bonds offer.
A lot has changed since our 2020 blog on green gilts, including the Chancellor announcing the issuance of the first-ever sovereign green bond, inaugurating a domestic green gilt market. On 27 January 2021, the UK Debt Management Office, on behalf of HM Treasury, appointed two banks as structuring advisers for this first issue of a green gilt. Subsequently, the March Budget included plans to issue green gilts twice in 2021, with total green gilt issuance for the financial year to be at least £15 billion. We continue to engage proactively with these institutions and with other industry working parties to express our own views on how these gilts should be put to market.
We have been long-term advocates for integrating environmental, social, and governance (ESG) considerations into the investment process for our clients, and are strong supporters of innovation in green growth and helping our clients navigate this new market.
So what have we been focusing on? There are four key areas of our engagement with stakeholders, through which we aim to align the issuance of green gilts with the needs of our clients:
1. An ESG perspective: We believe it’s important to understand how the characteristics of these bonds differ from their non-green counterparts – transparency and disclosure are key.
2. Use of proceeds: We believe the use of proceeds should be clearly defined and relate to the government’s overall strategy to achieve its climate objectives.
3. Functionality versus impact: We believe additional justification is necessary to explain any ‘greenium’, where green bonds have traded at more expensive levels than their non-green counterparts.
4. Maturity: We have expressed a preference that the maturities of green gilts should be longer dated, to enable long-term investors to aim to meet their long-term liabilities, and so that the government can finance longer-term environmental and social projects.
LDI: what role could green gilts play?
We believe it’s certainly possible that green gilts could play a role as part of a liability-driven investment (LDI) strategy; all else equal, we would expect to be able to consider green gilts part of the universe of eligible instruments for our clients. From an investment perspective, we would look to treat green gilts in the same way as their conventional ‘vanilla’ counterparts. For segregated and bespoke clients, this would include consideration of green gilts in the spheres of discretionary trades, rebalancing activity and active positions. Being able to choose between green or non-green gilts on a normal risk-return basis would also increase our opportunity set, without taking into account the ‘greenness’ of the gilt. We would also expect that pricing differentials between green and non-green gilts could lead to trade opportunities.
Potentially, investors seeking to prioritise the purchase of green gilts ahead of vanilla gilt counterparts may wish to consider additional mandate objectives such as specifying a minimum amount of green gilts to be held within their LDI portfolio, even if this does result in paying a slight premium.
In summary, LGIM will continue to support the government to catalyse a programme of green investment and seek to develop responsible investment initiatives to help meet the changing demands of our investor base.