Red, amber, green: where next for green gilts?

Following on from our previous blog, in this post we analyse the recently released UK Government Green Financing Framework, which has been prepared in line with ICMA standards and is also aligned with the Green Bond Principles according to the Second Party Opinion compiled by V.E. In this note, we highlight areas where we think positive developments have been made, and where we would like to see more progress.

As a reminder, irrespective of the bond label, we always evaluate ESG at the issuer level when considering a potential investment. However, focusing at the instrument level, we acknowledge the role of the sustainable bond market in catalysing greater disclosure, promoting sustainability objectives, and providing a framework for addressing the ‘impact’ of investments (whether on climate change or other social challenges).

Green light

We believe that the one of the highlights of the Framework is the inclusion of social co-benefits. There is little doubt that a transition to a low-carbon, resilient economy should involve boosting ‘green’ jobs and skills, and revitalising regions that have been in economic decline. LGIM supported the ‘Green + Gilt’ proposal and engaged as part of a group of investors – with a combined AUM of £10 trillion – to encourage the government to integrate social impact.

We therefore believe that the published Framework sends a positive signal and enables the government to ensure that capital is allocated to projects and regions which have been underserved by private capital.

Amber light

In our previous blog, we emphasised that the use of proceeds should be ‘additional’. One way in which this could be achieved is by using the proceeds to fund new green spending instead of refinancing older projects, and we had hoped to see a limit on the latter beyond a certain number of years. This has been partially addressed by the government’s commitment to using no more than 50% of green-bond proceeds for projects dating back more than one year prior to issuance, and to allocating expenditures within two years of the issuance date.

Whilst we think this does represent progress in the market overall, it is still on a par with other recent sovereign issuance and we believe the government is missing an opportunity to be more forward looking its approach. The UK Climate Change Committee’s finding that there is still a significant policy gap to be bridged in order to meet the UK’s climate-change targets signifies there will be a need for plenty of new funding requirements across a broad range of decarbonisation areas. Despite this we do not currently have an insight into how much spending will be financed by green or conventional gilts going forward.

An uphill journey?

We believe the sustainable bond market has the potential to foster more dialogue between investors and sovereign issuers, with whom engagement can be more challenging than with companies. Earlier this year, for example, we contributed to the Investment Association’s position paper on green gilts and asked for an ‘audit committee’ which would have representation from both the government and the investor community to review the use of proceeds and impact.

The Framework includes a Stakeholder Discussion Forum, with the aim of drawing upon specialist technical knowledge. However, we understand this does not include direct representation from the asset-management community, which has rather been front-loaded into the development of the Framework itself.

We believe that greater engagement with investors over the lifecycle of green gilts would foster greater discipline and accountability in the market. We therefore consider this a potential missed opportunity.

The policy jigsaw

Finally, we consider the green-gilt framework to be only one part of the policy jigsaw puzzle. In particular, investors will need more clarity around the definition of ‘green activities’ through the UK taxonomy (which is currently being developed) and around the role of the different technologies and industry developments that are intended to support the country’s overall net-zero strategy.

We have already seen challenges arise in the development of the EU taxonomy (part of which is now being addressed in the European Commission’s update to the EU Action Plan) and we believe investors should also consider how inconsistencies across different market-based taxonomies may add further complexity to their investment decisions.

In a constantly evolving asset class, which has not yet been brought to market in the UK, we will continue our engagement activities and provide updates on our latest views and analysis.