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Will the Green Bond Market Be Transformative or Transitional?
The Climate Bonds Initiative held its annual conference in London in early March. The event highlighted the dramatic growth of the green bond market in 2018—and how early in the market’s penetration we still are.
The drivers bringing investors to the green mortgage market are often the same as those that deter many more from participating. And the mission for existing market participants—such as Fanny Mae and Wells Fargo, which are originating loans, aggregating mortgages, and issuing mortgage-backed securities—is to better communicate their value.
In 2018, Fanny Mae increased its green mortgage portfolio to $50 billion. Because the lender operates in the secondary mortgage market it has to create attractive, compelling loan products to attract primary mortgage origination partners such as Wells Fargo (a bank in its own right) and asset managers like the real estate investment platform, StoneWeg. With enough green assets under management Fanny Mae can secure the portfolio by issuing a green bond into the market.
What Makes a Compelling Green Bond and Why Would Investors Buy It?
First, some key statistics:
- There were $183 billion of green bonds issued in 2018
- An increasing number of corporates are coming to market with green bond offerings
- An average bond will give investors exposure to around 50 commercial property loans
- Green bonds typically attract a triple A rating from agencies such as Moody’s, highlighting their low risk characteristics
- The majority of eligible mortgages are secured against commercial buildings
- The green bond market is made up of around 25 commercial lenders and 100 origination platforms
- Investing in low cost green initiatives saves on average 20%-40% water and energy consumption
Competing In the Mainstream Market
Green mortgage products must compete with mainstream products. The underlying financial product offered to borrower’s offers slightly higher leverage, an additional drawdown facility for retrofitting buildings with energy, and water savings technologies and independent energy audits. This incentivizes asset owners to choose the product. It has also created a new business model that transfers value from bond holders all the way to the tenants that occupy their properties.
Bond investors approach the story from a different angle: greener buildings have lower operating costs, which creates higher free cashflow and enables asset owners to charge higher rents because tenants have reduced monthly bills. Does this mean that the bonds are lower risk? And can they command a premium?
Bond investors have a fiduciary duty to seek the best value and manage risk. Accepting a green bond at a higher price (i.e., lower return) compared to traditional bond instruments could be a breach of that duty if the higher value cannot be justified.
Taking Green Mainstream
“Will the green bond market be transformative or transitional?”
Stephanie Sfakianos, head of sustainable capital markets,
Bond investors want to know if the bond is safe in their portfolio. Complexity is scary, and it is time consuming to accept a new investment product. Instead, the language that brings them to the table is best framed around improved risk management, higher debt service ratio coverage, and lower default rates.
For issuers of green bonds, the challenge to become a truly new asset class is simple: demonstrate higher transparency, better investment attributes, and lower risk factors. If green bond instruments begin to secure higher premiums more corporates will enter the market seeking lower cost capital for specific investment initiatives.
Growth is the one success factor that will determine if this new market will become transformative. At the Climate Bond Initiative conference, a representative of the International Finance Corporation highlighted that more than $13 trillion worth of low carbon buildings are predicted to be built in China alone. The challenge and opportunity for green financial instruments has never been more prime.