Sarah Mitchell, Senior Portfolio Manager – Global Green Bonds at Mondrian Investment Partners.

Andrew Putwain: Why is the consideration of brown issuers important to a net zero investment strategy?

Sarah Mitchell: The driving force behind sustainable investment is shifting capital and financing to support and ultimately achieve, amongst other things, environmental objectives. These include transitioning businesses and countries to net-zero activities and limiting global warming to 1.5 degrees Celsius. That’s the whole point behind asset classes like green bonds.

But the cost and the actions required to meet global emission reduction targets and to achieve net zero are huge. We have to accept that the current green sectors alone aren’t going to achieve this change. There is a need to provide financing to issuers that are willing and able to act and invest in projects that are going to enable the transition to net zero regardless of their sector and current core activities.

So, whilst to many it may seem counter-intuitive, this means that all sectors – including those engaged in fossil fuel and mining activities for example – should be encouraged into the world of sustainable financing. Shutting out these companies and countries that currently rely on such activities severely compromises any hope of genuine and meaningful transition.

"There is also no clear definition of brown sectors

so it must be framed in terms of transition."

We consider green bonds from any issuer and any sector with two broad criteria. First, that the proceeds of the bond issuance will exclusively fund environmentally beneficial projects as per our Green Analysis criteria. Second, that the issuer has a clear strategy to shift its business model to a sustainable footing. This naturally can result in inclusion of green bonds issued from traditionally brown sectors as long as the specific projects being funded are ones that work toward transition.

Capital allocation to green bonds that are funding genuine environmentally beneficial projects issued by companies in brown sectors is funding the transition and, arguably, those brown sector issuers can make the largest difference in terms of improvements in environmental impact. There is also no clear definition of brown sectors so it must be framed in terms of transition.

Some investors will consider green bonds from certain sectors or geographies as un-investable. However, we believe it’s a spectrum – and needs to be framed in terms of the transition. Geographical differences also have to be considered.

For example, the European green bond market is well established; reporting standards are high, and issuers have been issuing for a long time into a fairly developed green bond market. But emissions reduction has to be global to make an impact. Localised projects for emissions reduction are not going to get us where we need to be globally. We need to ensure we’re considering those markets with less developed green bonds. Just because an issuer is in a less developed green bond market with less stringent reporting standards, it doesn’t mean we should invest.

There is also the question of sovereign issuers. The green bond market originated from supranational issuers, but sovereigns (government issuers) have been a huge area of growth. For a long time, government green bond issuance was exclusively within the Europe, but more recently we have seen Canada, Singapore, and Indonesia come to the market. We’re also watching Japan’s plans for transition bond issuance.

Growth in government green bond issuance across all geographical regions is pivotal for the development of the market and this is an area we welcome and invest in on our green bond fund.

"Defining a ‘brown’ sector or issuer for sovereigns is basically impossible

because every government has brown activities within their mix."

Defining a ‘brown’ sector or issuer for sovereigns is basically impossible because every government has brown activities within their mix. Ignoring that reality stifles any optimal allocation of sustainable capital.

We apply the same rationale to sovereign green bonds as we do for every other green bond. As long as the bonds themselves – and therefore the projects they finance – meet our green analysis criteria, we will consider them eligible for investment, regardless of the current environmental credentials of the country issuing.

Sovereign green bonds are an important catalyst for overall green bond market growth.

Andrew: How can investing in brown issuers have an impact on the transition to net zero more broadly?

Sarah: Stepping back to first principles, if an investor wants to make a difference on the environment and transition to net zero, they should reward and deploy capital to the markets, sectors, and issuers that are striving for improvement in terms of environmental impact – instead of just rewarding the markets, sectors, and/or issuers that are already improved.

It's about ensuring these instruments finance the transition rather than solely provide capital to already green sectors. An example is ENGIE, a French energy company which is a large issuer of green bonds. They also continue to generate some of their electricity through coal-fired power plants. Being active in coal would lead to ENGIE’s green bonds being excluded by some investors; however, these green bonds pass the requirements of our green analysis and are held on our green bond fund. Their green bond framework is clear and supported by a second opinion. They publish impact reporting on a bond level basis and the projects funded are green and in alignment with the green bond principles and Sustainable Development Goals (SDGs).

Essentially, by funding ENGIE’s green bonds, we're investing in creating renewable capacity that's replacing coal electricity generation. It’s an example of an issuer in a traditionally brown sector, where green bonds are financing the transition to renewables.

"Engagement has a role to play for fixed income investors; issuers need to refinance, and a lot

of green bond issuers are government related and do not have equity as a source of funding."

I’m not using ENGIE as an example of the gold standard of a green bond issuer; it’s important to combine investment with engagement. By investing in the sectors that require capital to finance the transition, you’re at the table and you can engage to effect change.

Engagement is particularly important for issuers in traditionally brown sectors. We engage across global fixed income across all products, not just green bonds. Engagement has a role to play for fixed income investors; issuers need to refinance, and a lot of the large green bond issuers are government related and do not have equity as a source of funding. So, they need to have an eye on their standing in the debt markets for refinancing. This enables us to raise material issues with management.

Andrew: When looking for brown issuers with potential, what catches your eye? What factors are most important to consider – and where is there room for improvement?

Sarah: We apply the same investment process to issuers from brown sectors that we use for all bonds and issuers. We put every bond under consideration for holding on our green bond fund through our green analysis and review their overall sustainability strategy.

To determine if a bond is truly green – regardless of the issuer – we look for excellent disclosures and a strong green bond framework that sets out exactly what types of projects these bonds will be financing. There should also be a second party opinion from a reputable provider, and detailed impact reporting is also critical.

If we are investing in the green bonds of a traditionally brown sector issuer on the fund, we need to be absolutely sure it has passed through our internal green bond analysis. It’s also paramount to ensure that the issuer itself has a solid and transparent sustainability and transition strategy. This is because our goal is to push genuine transition – not simply to fund offshoot and non-strategic projects.

ESG analysis is factored into our standard fixed income investment process, which sits separately from this green analysis. So, there’s an analysis of wider ESG considerations – including the issuer’s environmental credentials – that feeds into the rating allocated to each issuer and the value demanded before we invest in their bonds.

We also engage with management. You can tell when you're engaging with people how important the idea of green bond issuance is and its importance to the organisation. So, there is the qualitative overlay as well as analysis of the data.

"There is work to do in terms of clarity around taxonomy alignment and information provision,

but it's important for asset managers because it helps them assess ‘greenness’ consistently."

There are ‘best-in-class’ elements we do look for. But, again, not everyone will be there, and there’s room for improvement on disclosures. Information we’d love to see more widely available is on additionality: are the projects financed new or are they refinancing of existing green projects? Ideally, we want to be investing in new green projects – putting capital to work on green projects that are having an additional impact on the transition rather than refinancing something that is already underway.

In terms of room for improvement in the green bond market more broadly, we consider the move towards a more common taxonomy to be key. We need to define ‘green’ to reduce the opportunity to greenwash. It’s a huge task, and the European Union (EU) taxonomy is a big step, with other jurisdictions – Singapore, for example – modelling their taxonomy on the EU’s.

There is work to do in terms of clarity around taxonomy alignment and information provision, but it's important for asset managers because it helps them assess ‘greenness’ consistently across markets.

We’d like to see more green issuance across sectors. There shouldn't be a stigma about issuing a green bond. If Equinor, for example, the Norwegian oil major, wanted to issue green bonds to finance their renewables projects – and had a clear company-level sustainable strategy – then it shouldn't be hesitant to do so.

Green bonds are a valuable vehicle to channel capital to environmentally beneficial projects. We'd like to see broader issuance for a range of sectors – helping achieve the climate transition and giving us the broadest and deepest green bond market to invest in on behalf of our clients.

 

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