How green financial assets are surging in value at an unprecedented pace (and what the pandemic has to do with it)
During the past 5 years green-energy companies’ shares have risen by 380%. Meanwhile, the S&P 500 and Euronext 100 gaze from below with envy at 90% and 33% respectively. These figures illustrate the astonishment that inspires this article : green financial securities are undergoing climactic surges in volume and value in both the debt and equity categories.
The aim of the article is to explain how the financial market for green assets came to be, when and why it developed, why it is blowing up during the pandemic, and what we can expect going forward.
Vocabulary
To enter the matter, it is worth defining a few terms we find often when dealing with Green Finance :
ESG : acronym standing for Entrepreneurial Social Governance ; that is, a corporate principle according to which companies should take into account social and environmental issues and combat them through their business model.
Green Bond : a bond whose issuer has declared it will use the received sum to finance a project that will have a positive social or environmental impact.
Premium : whenever a bond’s market price is higher than its face value (the amount the buyer will receive at the bond’s maturity date) we speak of a bond trading at a premium.
Greenium : refers to the price of a green bond that is beyond an equivalent non-green bond’s premium (i.e. higher prices for environmentally friendly investments).
1 - The slow advent of Green Finance
Let us look at the history of how green securities came about, who created them and where they began to be traded.
1.1 At the beginning there was the State (and supra-national institutions)
The first green bond was issued in 2007 by the European Investment Bank (EIB). Since 2014, the market has exploded: it has multiplied by nearly 40, going from 4.5 to 167 billion dollars in 2018. As a result, Green Bonds now represent about 2.8% of all bond issuance worldwide. For the coming years, forecasts are very optimistic. According to the rating agency Moody’s, even if in 2020 green bond issuance decreased from its 265-million-dollar peak in 2019 because of the pandemic, the green bond market is poised to skyrocket.
Since the Rio Earth Summit which (in 1992) recognized the existence of 4 major crises for humanity (the loss of biodiversity, climate change, deforestation, desertification) and produced two global conventions (on climate and on biodiversity) , new financial tools have been sought after in the world to boost the production of green energy, improve energy efficiency, reduce pollution caused by fossil fuels and reduce greenhouse gas emissions.
In 2001, elected officials of San Francisco City Council approved an authority responsible for issuing and managing climate-oriented municipal bonds. This is done through an amendment to the city's charter, called "solar bonds". These bonds must finance the rapid implementation of renewable energies (solar and wind power in particular) but also the energy efficiency of housing and public buildings. This proposal was then clearly motivated by the need for the city to take significant measures to combat climate change. This fund bolstered the city's renewable energy program.
From 2000 to 2010, the idea of green bonds mobilizing private capital progressed.
The World Bank coined the term "green bond" in 2008 when it launched its Strategic Framework for Development and Climate Change ,more precisely in this document drawn up in consultation with the 185 member countries of the World Bank, which has decided to make the fight against climate change a pillar of its development actions. By “green bond”, the World Bank then meant an eco-label for loans intended to finance sustainable development programs.
In 2017, the European Investment Bank (EIB) issued an equity index-linked bond, which became the first fixed-income product of socially responsible investing. This tool called the "Climate Awareness Bond" has been used to finance renewable energy and energy efficiency projects.
In 2018, the World Bank was then the first in the world to issue a “green bond”, of the “plain vanilla ” type (unlike climate bonds issued by the EIB).
The green bond market subsequently increased rapidly in terms of issuance from 2015 to 2016, according to the “Climate Bonds Initiative” there was a 92% increase in green bond issuance , which then amounted to 92 billion dollars. Other types of issuers began to emit green bonds, including Apple, which in 2016 was the first technology company to do so. Poland was ironically the first sovereign country to issue such bonds.
1.2 Then the general public and the private sector caught up
Overall, the trendiness of green assets may seem to be correlated to climate change awareness.
The increasing speed in climate change awareness has had an impact on the quantity of green assets exchanged on the market. Everything may seem to start from the public. According to a British study, 37% of global citizens put climate change as their top environmental issue. This inevitably makes companies take people’s concern as one of their main missions. As a result, nowadays, companies that do not take into account environmental issues seriously may end up having bad reputation. This state has an impact on financial markets. As the number of green “projects” increase, more and more investors are needed. The supply increases.
On the other side of the coin, the public who is also the investor ; whether it is personally or through funds, is increasingly concerned by the nature of the investments made with his savings. This is a clear message that Larry Fink, Blackrock’s CEO, made in his letter written in 2018 to the big American companies’ CEO. The demand for green assets increases.
Several changes are supporting the idea that “green” is the future. Beginning with the car industry, Tesla has set up the path in electric vehicles for other manufacturers to follow such as Mercedes, Audi, Renault. For the plane industry, Guillaume Faury, Airbus’ CEO, revealed plans to launch a zero emission plane based on hydrogen no later than year 2035.
All these changes are made possible thanks to the shift in investors' mind from traditional financial assets to green ones.
2 - The current state of affairs for green assets
Now that we know where green securities come from, we endeavor to understand the astonishing performance they have had during the past year and where they stand right now.
2.1 Debt class assets (bonds)
2020 left its mark on the continued dynamism of the sustainable finance market, mainly supported by the issuance of social bonds and the emergence of sustainability-linked bonds, driven by two main factors : the COVID-19 crisis -which highlighted the need to develop resilience to risks and shocks related to the environment-, and commitments to climate neutrality -some of which are already supported by long-term investment plans.
According to Damien de Saint Germain, Head of Credit & Strategy Research at Crédit Agricole CIB: “We expect the green, social and sustainable offer to accelerate in 2021. We estimate that it could reach EUR 600 billion, id est an increase of + 55% compared to 2020 emissions. "
This growth should be largely driven by the various European countries as well as by the European Union which could issue EUR 140 billion of green and social bonds. Agencies and supranational entities are expected to remain the main emitters by volume, with some of them switching the majority of their bond issuance to the sustainable format.
Diversification in terms of products is expected to continue, with sustainability-linked bonds and sustainable bonds representing around 20% of volume. Sustainability-linked bonds and bridging bonds could attract new issuers and cover new sectors. Finally, assets in euros should still represent 60% of worldwide issuance.
What about the French State ?
The amount of eligible green expenditure to which the issuance of government green bonds will be linked in 2021 will amount to 15 billion euros for the year 2021. This envelope, which amounted to 8 billion euros in 2018 and 2019, is therefore up sharply thanks to the backing of State support for renewable energies, previously financed by an assigned tax.
As announced by Bruno Le Maire, Minister of the Economy, Finance and Recovery, on the occasion of the Climate Finance Day , the Agence France Trésor (an organization which handles the Public debt) will create a second green bond, with a maturity of close to twenty years, subject to market conditions. In addition, it will continue to top up its first green bond, issued for the first time in January 2017, based on investor demand. All of these issues will be carried out within the limit of the amount of eligible green expenses for 2021.
The abundance of green bonds from governments is met with a high demand which, in driving bond prices up, it pulls down their yield. According to the MSCI, in 2019 the average green bond issued in dollars had a premium, with an average maturity of 8.75 years, coupon of 3.40% and an issuance yield of 3.27%. When it comes to normal government bonds, Morningstar reports that, since 1926, long-term US Treasury bonds issued in American dollars have returned between 5% and 6%.
It seems a similar gap between green and normal bonds exists for corporations : according to a 2020 MSCI study, corporate green bonds tend to offer yields 0 to 2 basis points lower than comparable non-green corporate bonds.
This could be explained by the current trend for fund managers to constitute a portfolio comprising green bonds as a part of their ESG strategy, leading them to acquire this kind of bonds without hesitation.
2.2 Equity class assets (shares)
As previously mentioned, electric car and power outlet manufacturer Tesla recently became the most valuable car company in the world with a staggering market capitalization of $823.92b3. Although it is believed the surge of Tesla’s stock is due to an irrational trading frenzy to a certain extent, green-tech companies’ fundamentals are unequivocally gaining long term value.
In the span of the year 2020, the two top spots in the ranking of US equity funds with the highest returns went to Invesco Solar ETF and Invesco WilderHill Clean Energy ETF with 238% and 220% year to date returns respectively as of December 24. Invesco is the asset management company that holds those two funds, it turns out the aforementioned financial vehicles both specialize in green energy assets. In the eyes of Rene Reyna, the company’s head of thematic and specialty product strategy, the outstanding performance we see in green-related assets is underpinned by a true enhancement of economic fundamentals : “underlying fundamentals within the renewable energy sector support our view that we are in the early stages of a longer-term secular growth trend.”
According to Lazard, it is thanks to increased competition, technological progress and an uninterrupted decrease in cost of capital that the average costs of renewable energy have been reduced over the last decade.
In dollars per Megawatt hour, Lazard’s 2020 calculations state over the ten years following 2009 Solar Power decreased its price by 89% going from $359 down to just $40, while Wind Power descended from $135 to $49, that is a 70% shrinkage.
The resulting performance of green equity assets is unheard of : while the year on year return as of feb 12 2021 of the S&P 500 was 16.34%, NASDAQ’s Clean Edge Green Energy (CELS) overshadowed it at 196%. The current trend for energy sector investors is to turn towards green energy shares, whose current rates of growth eclipse those of the traditional energy sector, especially Big Oil : NextEra, the biggest American energy company by capitalization ($147B) and biggest single producer of renewable energy in the world, saw its shares increase by 76% in value over the past two years whereas ExxonMobil stood at a 60% decrease.
3 - What to expect for 2021 and the relatively near future
Most of green bond issuance in 2020 was due to the generalized will by Governments and Central Banks around the world to shape the ineluctable economic stimulus -ongoing, to be furthered, and to come- in such a way that the industries that will be bolstered fulfill the double role of creating jobs and a better, more sustainable society.
3.1 The great reset and the future of Bonds
500$Bn in Green Bonds will be issued next year, according to the Swedish Bank SEB. 225€Bn will come from the EU’s 750€Bn recovery plan alone. Now, when it comes to the profitability of these assets, it must be said we are not looking at the Holy Grail of profit seekers.
Indeed, the premium at which they trade makes their yield very low. This suggests that investors find value in the special purpose of the bond rather than in the profitability thereof. This suggestion is supported by the fact that green bonds and normal bonds issued by the same borrower at same maturity and coupon have equal yields today and at times the green version even trades at a “Greenium” insinuating investors trade off wealth for sustainability.
The fact that overall perceived risk is decreasing, and the subsequent shrinkage of the risk premium, translates into a lower cost of capital for green projects and companies. Ceteris Paribus this would mean companies can reach new financing boundaries thereby enjoying newfound paths of growth.
3.2 What the Green-Recovery trend means for stocks
We have mentioned in our previous article Risk Management for Green Finance that the main hurdle to green companies’ financing comes from the perceived (often overestimated) risk of such types of projects. We also mentioned that one decisive factor which reassures private investors when allocating their capital is the institutional environment surrounding the project. A political and judiciary setting on behalf of the green transition ensures a solid and long-lasting market for green companies : be it from the government itself acting as the demand or as a catalyser for private demand by subsidizing green products or establishing public infrastructure that facilitates the spread of green products (such as Norway’s abundantly scattered power stations).
As manufacturing comes back from its provisional hibernation due to the pandemic, corporate revenues recuperate a more rosy outlook and with their new financing capacity the trend of consolidation can only continue. Companies like NextEra had started acquiring other companies to extend their grid. The growth of such companies and the consolidation of the Green Energy market will further bolster green assets’ price.
3.3 Risks and uncertainties
3.3.1 The underlying threat of monetary neutralization backfiring
Since the covid pandemic started Central Banks have enacted generous monetary policies through interest rates and open market transactions. For instance, the Fed has cut its target for the federal funds rate by a total of 1.5 percentage points since March 3, bringing it down to a range of 0% to 0.25%. On the 18th of March the European Central Bank announced a EUR 750B Pandemic Emergency Purchase Programme injecting monumental sums of liquidity mainly to funds i.e. the financial markets.
It could be that it is this increased liquidity that underpins the virtuous tandem which stokes the demand for green debt assets. If this monetary environment is reverted (and everything suggests it will, for it is not a durable macroeconomic policy), there is a chance it will have an exaggerated effect on the demand for green debt, thus decimating the alleged “Greenium” and tightening green companies’ financing capacities once more.
3.3.2 The underlying threat of monetary neutralization backfiring
Conclusion
PwC expects a threefold increase in value of ESG funds' assets by 2025, advancing their share of the European fund sector from 15% to 57%. Even in PwC’s base-case scenario, sustainable funds would increase their share of the European fund market to 41 per cent by the mid decade, with assets rising from €1.7Tn to €5.5Tn.
As the title of this article suggests, green financial assets are on the rise ; we have hereby argued that this trend’s three main driving forces are technological progress, increased market competition and a will to change things shared by both the public and private sectors. Investors seeking to make a profit and yield high returns would have greatly benefited from having acquired green securities over the last few years.
Whether or not the unparalleled spike these securities met in 2020 will continue down the line is uncertain : the trend may slow down after (and if) governments scale down their recovery programmes or central banks tighten up monetary policies. The global momentum for the transition to a sustainable economic model, however, is all the more likely to continue as it is seen more and more as a necessity for the well-being of future generations. Hence we expect financial indicators to follow the upwards trend that the green industry is pursuing.
However we should not forget that at least for now a large part of green assets are still negatively correlated to the oil market, making oil the major driver of green stocks, as lastmonth's skyrocketing trend of Brent oil has shown