Corporate Q&A

‘Fifty shades of green’

How Luxembourg is looking to host more sustainable bonds from China


Scharfe: Luxembourg bourse CEO

In September Xi Jinping, the Chinese leader, pledged that the Chinese would achieve carbon neutrality by 2060. But a huge amount of investment is needed to get there: Rmb138 trillion ($20 trillion) invested in energy systems alone is Tsinghua University’s best guess, with much of that coming from the private sector, putting more of the focus on China’s green bond market than ever before.

The Chinese have been green bond issuers since 2015, with total outstanding issuance of $140 billion at the end of last year, which amounts to the world’s largest green bond market. Yet international investors – many of them with an ESG (environmental, social and corporate governance) mandate – still find it difficult to trade in China’s green bonds because of language barriers and differences in areas like issuer standards and reporting. This is a challenge that the Luxembourg Stock Exchange is trying to address with the launch of the Green Bond Channel – created in partnership with the Shanghai Stock Exchange – which offers a fuller range of information on domestic Chinese bonds to offshore investors.

WiC spoke with the Luxembourg bourse’s CEO Robert Scharfe about how the channel works, as well as how he sees the wider development of China’s green bond market.

What prompted the Luxembourg Stock Exchange to launch a dedicated platform for green bonds? Has it lived up to your expectations?

The Luxembourg Green Exchange was launched in September 2016, soon after the United Nations communicated the 17 Sustainable Development Goals (SDGs) to be achieved by 2030, and when the Paris Agreement on climate change was signed. As an exchange, we were hoping to contribute to the above causes by promoting sustainable finance, such that capital could be reoriented into projects that have a positive climate impact.

We decided to build a platform that was dedicated to green products. It started with bonds but it has also included funds over time. And its performance has more than met our expectations: four years after its launch, the Luxembourg Green Exchange is still the world’s leader in sustainable financial products today, hosting roughly 850 securities that are worth a total of $400 billion. In fact we command nearly half the global market of sustainable bonds.

How have you achieved 50% market share worldwide?

The Luxembourg Stock Exchange has focused on and specialised in the listing of international securities, predominantly bonds and other debt instruments, since the 1960s. It has always been at the forefront of innovation in capital markets. So when a new instrument comes to market, the Luxembourg Stock Exchange is always the first to look at it, as well as to guide issuers on the listing process and documentation.

A key success factor is the transparency we can provide to international investors. There are over 37,000 securities listed on our exchange and investors will have no trouble finding reliable information on them because all the relevant documentation is freely accessible on our platform.

That applies to green bonds as well, on which we provide both regulatory and non-regulatory data. This covers the prospectuses and other documents that regulators require, as well as the information about how issuers allocate their green funds and the actual impact of their projects as assessed by third-party experts, etc.

One point where I would like to draw your attention is that bonds can only be displayed on the Luxembourg Green Exchange if they comply with our standards. In fact, we went beyond best practice in the market and made voluntary guidelines mandatory for display on our green platform. In short, bond issuers like us for the visibility we bring to their sustainable products, and bond investors appreciate us for the access to primary information.

How many of the green listings on the Luxembourg Green Exchange came from China?

Of the 85 bonds coming from China, we have six green bonds that comply with international standards, notably the Climate Bonds Initiative and the International Capital Market Association. Although the current number is relatively small, valuation-wise it’s huge. Together they have a combined value of above $700 billion. They’re all financial institutions that have tapped the international market and are therefore tradable on our platform, including China Development Bank, ICBC and China Construction Bank.

Why are green issuers from China so skewed towards financial services firms?

The easiest explanation is that a lot of these Chinese financial institutions are international organisations already. They have a worldwide presence and they understand how to follow international standards and how to access capital markets under diverse forms so as to finance sustainable projects outside China.

The Chinese have been prominent green bond issuers. Is there a reason why there are relatively few Chinese issuers on the Luxembourg Stock Exchange? They have problems complying with all your standards?

That’s definitely a factor. Most of the documentation on Chinese green bonds, especially the domestic ones that aren’t tradable outside China, exists only in the Chinese language. Of course, getting interest from international investors who can’t understand the underlying projects of the bonds is difficult. But that is also why we created this link between China and Luxembourg, and why we make all the information on these bonds available in English.

Recently Xi Jinping pledged that China is going to achieve carbon neutrality by 2060. How will that goal affect the size of new green offerings? What sort of growth can we expect in terms of volume?

What is for sure is that the declaration by President Xi is very ambitious, setting a deadline for China’s carbon neutrality goal just 10 years after that of the European Union, which has already done quite a lot to combat climate change.

It also tells us that leaderships around the world have come to the realisation that economic development models need to change and above all that we need sustainable infrastructure going forward.

This requires an enormous amount of funding and it’s very clear that the public sector alone cannot fund all the projects required to reach these objectives. Therefore we are at the start of an era where we have to mobilise private capital to finance sustainable infrastructure.

With this in mind, and looking at the outstanding size of sustainable financial instruments, there will be massive amounts of new transactions that need to come to the market to create project capital.

A few weeks ago the European Union sold a €17 billion ($20 billion) social bond, which is the biggest social bond ever issued in the capital markets, generating an order book of €233 billion, making it more than 13 times oversubscribed, an amount never seen in capital markets before. This order of magnitude was unimaginable six months ago and around 64% of demand came from investors, who said: “I’m not going to put a single euro in financial instruments other than sustainable products.” If this happens more broadly and repeatedly, issuers will have no choice but to issue sustainable financial instruments.

Funds raised from Chinese green bonds can go towards activities such as improving efficiency at coal-fired power plants. This has been a contentious issue with international green bond investors. What is LGX’s position on it?

There isn’t just one type of investor. It’s not a black and white picture. There are 50 shades of green instruments out there in the market, and there are probably 200 shades of green investors, who all have different policies, constraints, preferences and so on.

A typical ESG investor would not invest in a bond that supports carbon or coal-fired projects but there might be impact investors who believe that helping China move from dark coal or brown coal to clean coal is a major step forward in CO2 reduction. These kinds of investors might like these kinds of bonds.

We have a number of standards and not all bonds are eligible to be displayed on our platform. The good news is that China has clearly understood the message from investors as it is opening its own markets to foreign capital. Equally, the decision by the People’s Bank of China early on this year to exclude coal from its catalogue of activities eligible for green bonds is a major step towards greater harmonisation between Chinese and international standards. That is very positive news. Investors like it and they will look more closely at Chinese green or sustainable bonds in the future.

Different authorities in China regulate different types of bonds and provide different guidelines for issuance. Inconsistent standards can be confusing to investors. Does LGX provide solutions to address this?

We are market infrastructure and our role is to provide information. From day one we have taken an inclusive attitude, rather than being exclusive and judgmental. If you look at our website, we are not mixing up European green bonds with Chinese green bonds. We have different sections and we inform our investors what the different standards are. It’s up to them to decide on their preferences, based on the information we provide.

Then again, we just talked about the PBoC’s adaptation of its green catalogue, which I believe is the result of numerous interactions between European organisations, including the Luxembourg Stock Exchange, and the Chinese authorities and other market actors.

There are other examples: when ICBC, a bank, issued its climate bond in 2017, it corresponded to international standards and it was certified by Chinese standards. Clearly the gap between these various standards was not enormous. I believe 85-90% of these standards are similar or comparable. Then you have maybe 10-15% of local differences but the question is: do we focus on the 85% commonality or the 15% in differences?

Sure enough, the 15% needs to be clearly identified in the documentation. But ultimately I believe that green, social and sustainable financial instruments are making waves in capital markets. The differences or gaps between different standards will narrow further over the years to come.

Almost 51% of the funds raised through Chinese green bonds weren’t earmarked for specific purposes because their issuers were financial services providers, with final allocations pending. And around 47% of the average size of issuance was deployed to working capital, which could be ‘ungreen’. Is that a big concern for investors?

An ESG investor typically needs to know the use of proceeds of a green bond before buying that instrument. If this transparency is not offered, the investor won’t consider the financial instrument.

There was a phase where some bonds in the market were more precise and some less so about their use of proceeds, which is what I meant by the ‘50 shades of green’ earlier. But luckily all of that has changed dramatically in the last couple of years. Today you can hardly find a green bond issuer willing to put in all the extra effort in documentation to report only 75% of the use of proceeds but not the remaining 25%. More remarkably, these kinds of bonds are simply disregarded by ESG investors today.

More and more institutional investors are imposing their own ESG criteria because their clients require these companies to act responsibly. That also explains why we’ve issued ESG guidelines for asset managers, which highlight what they should focus on when it comes to reporting, and the processes they need to set up to attract investors.

In short: it’s not only the underlying projects that have to be ESG-compliant. Asset managers and listed companies need to have ESG profiles too because that is what investors want to know about. That is a fundamental change in the market.

Do you see changes in investor behaviour? Is there more willingness to pay a premium for green issuers now compared to a few years ago?

The premium that you find in the market today is more the result of the imbalance of supply and demand. A bond that is multiple times oversubscribed in the primary market, of course, tends to be expensive in the secondary market. But if you are an ESG investor, and you have no choice but to buy whatever is available in the market, then you’ll need to pay a premium.

That’s why it is important to have benchmark international issuances, which help to produce the liquidity in the market and normalise the pricing of green bonds versus conventional ones. As the market for green bonds broadens and deepens, conventional bonds will probably need to offer a much higher yield in the future, simply because there will be fewer investors willing to buy bonds that are not compliant with ESG criteria.

Do you agree that we should have more information on the effectiveness of green bonds in delivering a positive impact?

Capital markets are experiencing a paradigm shift. Green bonds, social bonds or sustainability bonds are efficient instruments as they’re the only financial instruments today where you can be sure that the proceeds are being deployed for sustainable projects. So every green bond that comes to the market is good news. But what’s certainly going to evolve is the post-issuance reports, or impact reports, that issuers produce for the market over the lifetime of the bond itself.

These reports will become more detailed and more precise, with more transparency, because investors need to understand the impact of their investments. It is not enough to say a bond will lead to a decrease in CO2 emissions – the question of “by how much” will have to be addressed as well.

Look at a green bond from 2015 and another one issued last week – you will see that their post- issuance reports are already quite different in content. But going forward, bonds that perform better than others in reporting will attract more investors.

How will the reporting evolve?

There will be more standardisation because that is what investors need. A few weeks ago we launched the LGX DataHub, taking the initiative to slice up the reports of all green bonds into 150 data points, as opposed to just putting the documents in their raw form online. These data points can be used as yardsticks for comparing and contrasting different green bonds. For example, investors can evaluate the quality of the second opinions on a project financed by a green bond against its peers, or look at how its terms and conditions are different from others.

With the EU and China steering their economies to carbon neutrality by 2050 and 2060 respectively, there will be a period where transition bonds boom because companies need to transform their business models. These instruments in particular will need to have clear metrics in their reports, so that investors can decide whether the bonds meet their criteria, and whether they can buy them or not.

Do you think there will be more green bond issuers from non-financial services firms from China in the next few years?

I think it’ll be a trend globally. Today there is a predominance of financial institutions in the international market. But it’s changing and it will have to change further. You’ll find the whole spectrum of issuers, from public to semi-public to private entities. Nobody can afford to ignore ESG in their business or financing models anymore.

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