Unanswered questions surround government's green bonds plan

This marks a departure for the UK government as it will be the first time bonds have been issued with an explicit environmental focus. 

Several other countries, most notably Italy, Germany and France, have previously issued green bonds, and many companies also do so. 

But unlike regular government bonds, the green bonds will be available via National Savings and Investments, and so available to retail investors. No interest rate has yet been revealed, but the intention is to sell two tranches of the bonds in the summer of 2021 and raise £15bn for the government's coffers.

Laith Khalaf, financial analyst at AJ Bell says: “The new NS&I green bonds are likely to sell like hotcakes, seeing as environmental concerns are really beginning to take hold with savers and investors.

"The product is expected to land in summer, hopefully enough time for NS&I to sort out the administration problems it has encountered of late, before it’s hit with a fresh wave of demand.

"The interest rate paid on the bond will be a key determinant of its success. Too low, and it won’t put bums on seats, too high and there are inevitably questions about costs to the taxpayer, as there were with George Osborne’s NS&I “Pensioner Bonds”.

"The green bond doesn’t form part of NS&I’s finance target for next year, which suggests the Treasury has high hopes for its popularity.”

David Czupryna, head of ESG at French asset management firm Candriam, says the most recent sale of green bond by the Italian government was oversubscribed, that is, there were more willing buyers for the bonds than there were available bonds.

He says the yield on the green bonds of many countries presently trades at a higher price (and so has a lower yield) than the regular government bonds of the same countries. 

Bryn Jones is fixed income director at Rathbones Unit Trust Management, and also an Investment Association representative to the government’s debt management office, which issues the UK's government bonds. 

Among his responsibilities at Rathbones is the management of about £2.4bn of assets in the Rathbone Ethical Bond funds. 

His long-standing policy is to exclude all regular bonds issued by governments on the basis that government’s maintain armies, and, in many cases own nuclear weapons, and so the bonds used to fund government expenditure are rarely ethical. 

Jones is however keen to look at the UK government’s plan to issue green bonds, which was announced in the Budget.

The plan is to issue £15bn worth, but he says there are many unanswered questions.

Maturity date

One of these is around the date to maturity of the bonds, and also the underlying assets the money will be invested in.

The length of time until the maturity of the bonds, known, as the duration, will likely be determined by the length of time it takes to construct each individual project the cash raised is used to finance.

With regular government bonds, the cash just goes to the government's general account,  but with the green bonds he feels it is likely the bonds will be issued to fund named projects. 

Jones says: “It is always important with something like a green bond to know what the capital will ultimately be used for; we know for example, of a green bond that was launched by a company that operates oil tankers. They use the capital to make the tankers that carries the oil around more energy efficient.

"From an ESG point of view that is a waste of time. The second consideration is around duration, we have not had a lot of clarity on that yet. I have been asking these questions, but have not an answer.”

Czupryna says the price of green bonds issued by companies tends to be reliant on the quality of the project the capital is being invested in, more than of the company issuing the bond.  

Jones believes that government-issue green bonds will perform roughly the same way as other government bonds, making them neither more nor less risky, and for this reason, the ESG consideration is paramount.

Sam Buckingham, vice president of investment strategy at investment management firm Kingswood says: “The principle of green savings bonds will be very attractive to retail investors who have an ESG and sustainable mindset.

"While there is little detail known about the bonds as of yet, one characteristic retail investors should be aware of is that green bonds can be used to invest in existing projects as well as new ones.

"We would expect investors to have a preference for providing capital for new projects as opposed to servicing ones already in place, though this remains to be seen.

Bond yields

"Another unknown is the yield these bonds will pay. What we have found for green bonds is that, due to their high demand, they typically pay lower yields than traditional bonds. With yields already so low, particularly in the government bond space, retail investors should be aware of this as it is possible their investment will lose value in real terms, that is, when accounting for inflation.”

Government bonds have sold off starkly in recent weeks as investors begin to fear higher inflation. Jones says all fixed income investments are priced relative to the yield on regular government bonds, so if the latter fall in value, the rest of the market is likely to as well. 

Another uncertainty for investors looking at green bonds is that such instruments cannot currently be issued under UK law. 

Under an 1968 Act of parliament, the government cannot issue bonds to pay for specific projects; all of the capital raised from the sale of government bonds must go into the same account. 

Jones says when he highlighted this to officials at the Debt Management Office he was told they can issue green bonds, despite the 1968 Act, but did not elaborate on how this is so.

David Thorpe is special projects editor of FTAdviser

david.thorpe@ft.com