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A new green union for Europe

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BNP Paribas Asset Management
 

The European Union’s plans to issue up to EUR  225  billion – some 30% of its coronavirus recovery package – in green bonds could almost double the global market, add significant liquidity to it and lead to a green yield curve.

In her first State of the Union address, European Commission (EC) President Ursula von der Leyen announced that some 30% of the EUR 750 billion #NextGenerationEU budget will be raised through green bonds. The belief is that green projects – those that bring environmental or social benefits – could be developed for less since ample new capital can help reduce costs.

The planned EUR 225 billion in green bond issuance would play a major role in helping to deliver the EU’s new tougher target of a 55% reduction in greenhouse gas (GHG) emissions by 2030 – a big increase on the previous target of 40%.

30% of Recovery and Resilience Facility (RRF) via green bonds

Green bond issuers have an obligation to ring-fence the proceeds of green bonds so that these are allocated to green projects only. They also have to disclose how they determine that a project is actually green. Funding almost one-third of the RRF through green bonds should help to ensure that the facility can keep its commitment to a green recovery.

The EU’s efforts will enable the expansion of investment in green assets, but could also lead to the creation of a green bond yield curve.

The green bond issuance will also help to support the EU’s target of 32% of energy consumption through renewable sources by 2030.

Transition to a low carbon era

Ms von der Leyen’s speech arguably marks the start of Europe’s transition to a low carbon economy era and the initiatives announced could help the EU become the benchmark for other regions in establishing an impactful commitment to enabling a green transition.

The key points in the address that targeted green investment included the announcement that 30% of the capital raised through green bond issuance be strictly allocated to green projects. The green project selection process is typically reviewed by an outside auditor to ensure it is robust, and that the green capital allocation remains transparent throughout the life of the bonds.

In effect, by using green bonds, the Commission can ensure that the facility follows through on its green ambitions and helps protect investors from greenwashing.

New opportunities in credit investment?

The EU’s massive green bond issuance will help create another potential risk-free green asset,  opening up new opportunities in credit investment.

It is possible that the EU will create a green curve for euro bonds, with the first issuance due in late Q4 2020 or early Q1 2021. As the Commission plans to deploy more than half of the RRF in the first two years, it is likely that most of the EUR 225 billion in green bonds will come over the next year.

The green bond market will likely expand rapidly in 2021, possibly doubling in size from 2019.  It is possible that the EU alone will issue over EUR 100 billion in green bonds next year. Examples indicating the scale of demand for green bonds include the recent Green German Bund being five-times oversubscribed and Luxembourg’s Sustainability bond being eight-times oversubscribed.

In short, demand for high-quality green debt is high and appears likely to remain so. Future developments could include the issuance of various maturities, creating a green curve, and a second potential risk-free green asset that will complement the Green Bund.

Green growth, green profits

The increase in issuance of green bonds looks set to act as a catalyst to accelerate the development of green projects. Among the reasons for taking that view are:

  1. Today, renewable energy generation in the EU is competitive when compared to fossil fuel energy generation. This has already resulted in more renewable energy capacity being built for purely economic reasons. This competitiveness could work in favour of borrowers as loans comprise a large share of the RRF. Lower returns on operational renewable energy plants (typically returns in excess of 5%-6% in the EU) mean that loans funding renewable energy projects should see a high repayment rate.
  2. The issuance of collective European debt will make cheaper capital available for all EU members to help develop green projects. Under the RRF, individual companies will need to apply for aid via their home country, with the country in turn applying for support from the RRF. This will reduce the need for the home country to raise capital using its own balance sheet in the open market, and increase the potential return from project developers.
  3. The better cost of capital could also lead to a reduction in the cost of renewable energy development. This could, in turn, lead to lower renewable energy prices, making fossil fuel generation less attractive. This is expected to result in a positive feedback loop of greater demand from consumers for green services, which could well be complemented by an increase in investor flows into green assets.

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice.

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