Different year, same themes; climate will move centre stage
Many of the same topics that global financial markets participants will be confronting in 2020 will be the same as those they tried to fathom in 2019
AS we start 2020, many of the same topics that global financial markets participants will be confronting will be the same as those they have already been trying to fathom in the past year. Stating the obvious, maybe, but I only say that as I’ve been reading a lot of market commentaries pondering what the major market-moving topics of the coming year might be.
Economic growth, monetary policy actions, the interplay between monetary and fiscal levers, global trade, corporate profitability, equity valuations and the direction of credit spreads are all perennial market topics. In Europe, the fate of the banking sector is still high up the agenda, as banks endeavour to find a way to generate sustainable through-the-cycle profitability in an ultra-low interest-rate environment.
These topics are hardly going to disappear as driving macro themes as if by magic. Even if we wished some of them would (like Brexit).
Accepted market wisdoms can and do change, however. For evidence, look no further than the US Treasury market. The relentless one-way flattening of the 2-10 spread has markedly reversed course since the inversion of August 2019 to around the +30bp area. Curve inversion, we were told at the time, was a sure-fire sign that the US was heading into recession. Not everyone agreed, but it certainly caught the market’s imagination as an accepted truism.
Well, we’re now back to spread levels not seen since the autumn of 2018. Many would now have us believe that that augurs higher growth and inflation. Again, the subject of hot debate but how things change.
Of course, geopolitical and political factors (prepare to be numbed this year by a crescendo of bipartisan zeal around the US presidential election as the year progresses) will continue to add layers of white noise and confusion to investment decisions. The only market uncertainties, as ever, will be the unknown unknowns that you can guarantee will always come onto the market radar, with the power to cause bouts of volatility, be they short-run or more systemic.
From a capital markets perspective, a year of crushingly negative bond yields – even in some areas of the high-yield market – was a central topic. With Christine Lagarde at the helm of the ECB, we won’t see drastic short-term policy shifts, even if the new president has instigated a strategic review. It looks like the era of low rates will be with us for another year.
One net impact of the rate environment was a 9.3% increase in international bond issuance in 2019 to around US$4 trillion, according to Refinitiv, as issuers took the opportunity to tap the market to refinance and term out at incredibly tight levels.
If one specific theme moved increasingly centre stage for the institutional capital markets in 2019, it was climate. Green finance has become a hot topic in recent years and there are plenty of people out there who will scream from the rooftops about the growth of green bonds. But I remain unconvinced. Not by the importance of tackling climate-change but by labelled green bonds as a tool on their own to drive significant environmental change.
International green bond issuance increased by around 50% between 2018 and 2019. And statistically, the proportion of international green bonds in total bond issuance rose by 37%. That’s impressive, right? Well, it is until you factor in the fact that even with that rapid growth, labelled international green bonds in 2019 accounted for less than 4% of that US$4 trillion total I quoted above. That’s far from impressive. As is the almost total complete absence of industrial issuers from polluting sectors of the economy in this market.
I may be in a small minority but I remain unconvinced that labelled green bonds issued under the Green Bond Principles or the Climate Bonds Initiative’s certification scheme are the answer. I firmly believe the market needs not to stop but to shift its focus away from financing pure-play companies (where climate impacts are by definition de minimis) to the more vexed topic of how to accelerate the environmental transition of companies in polluting sectors such as oil and gas, extractives, and chemicals.
The emergence of transition bonds or bonds issued at the corporate level with environmental covenants could provide better avenues for corporates in these sectors. Italian electricity utility Enel blazed the trail for corporate-level bonds in September and October, selling US$1.5 billion and 2.5 billion euros in general purpose corporate bonds linked to various SDG goals and committing to source a minimum of 55% of installed capacity from renewable sources by the end of 2021.
AXA Investment Management (which came out with a blueprint for transition bonds in June) subscribed fully to the first transition bond issued in line with its guidance in November: a 100 million euro 10-year private placement by Crédit Agricole CIB. The bank will use the proceeds to lend to projects in carbon-intensive sectors that contribute to the transition to a low-carbon economy, such as LNG-powered ships, investments in energy efficient industries as well as gas power assets in countries where power generation currently relies on coal.
As a postscript to the green finance story, BP Capital Markets America offered a potentially noteworthy feature in the US$500 million 3.06% 30-year senior unsecured private placement it sold in December.
The bond has an issuer call option running from March 31 2025. But interestingly, the issuer also granted bondholders a put option running from the same date at a price of 94.02. Chatter around the bond suggested this provided investors with a backstop exit price to compensate for energy transition risk that is expected to increase over the life of the 30-year bond. I’ll take the transition risk element under advisement pending more discussion. But if oil majors are thinking about the world in these terms, it could signal a major shift in the critical environmental finance segment.
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