Bloomberg: The Road to Financing the Net Zero Energy Transition

Sonali Basak: There’s a lot of talk about green initiatives rising in the mind of investors, but if we're looking at how much that translates to in dollars, what does that mean?

Sean Kidney: The thematic market where the proceeds go towards addressing climate change, social investments, and sustainable investments is booming. According to Bloomberg figures, we had something like $760 billion of issuance last year, and we're sitting at about $1.7 trillion outstanding. The green bond market, which is the area I most intimately work in, is sitting at about a $1.1 trillion outstanding at the moment. It's not exactly huge compared to the overall bond market, but it's pretty good and growing fast. 

The investor demand is extraordinary. The level of oversubscription for these thematic bonds is way higher than normal bonds, and when I speak to my investors they simply can't get enough. Their asset owners are telling them they're interested in this sort of thematic portfolio, and this is washing over to equities and other instruments as well. We've just had a brutal pandemic; we've just had a collapse of economies in some places, but there's a story there. People are realizing that the capital with purpose story is a story of the times.

Sonali Basak: Amy, what do you think the pandemic has done to really add to ESG conversation? Is there a link?

Amy West: For those of us involved in the markets, there was a bit of uncertainty and unease as the pandemic set in. As Sean said, the ESG markets are still much smaller than the overall debt markets and we hadn't been through a systemic financial shock since the financial crisis, so this was the first time since this market has had that happen.

In that context, I was blown away by how positive the response was to this type of thematic investing. We saw more transactions get done, and in particular social transactions. Social bonds were seven times higher in issuance levels in 2020 than we'd ever seen before. There was really a response from the global investor base that this wasn't just about doing the right thing, but this was an indicator of success. You've seen it with some recent articles from institutions like BlackRock, where we saw outperformance of a number of the sustainably focused funds. If you look at the UN PRI numbers from the end of last year, there's more money being managed in the world today through a thematic lens, than there's ever been before. The amount of money that's not using ESG is rapidly dwindling. I think this is here to stay, and that we'll continue to see more focus on it. The pandemic, in my mind, only really helped to crystallize ESG as a material, financial risk.

Sonali Basak: Deborah, maybe we can bring in an investor's perspective here. Amy brought up a great point about the social bonds. When you're looking at ESG as a category, how do you divide and conquer the E, S, and G elements of it?

Deborah Ng: We've always asked how much performance you get from looking at ESG factors? But, the fact of the matter is that there's so many different elements and types of investments that are put under that ESG header that you really think about where we as investors want to have impact? 

Do we want it from the environmental side? We're seeing a lot of opportunities on decarbonization technologies and that's a huge area of focus for us. On the social side, it's really about positive impact. We're thinking about investing in issues like inequality and education as well, so I think investors are getting pickier about the ESG themes that they're going to be looking at.

Sonali Basak: Amy, when you were saying that more people are looking at social bonds, what does that look like? Where does that money go?

Amy West: I think that the difference between the traditional and green markets—which were environmentally focused use of proceeds and transactions—is that the social category is much bigger. It could be a number of social initiatives from things like affordable housing, all the way through to the response to the pandemic—healthcare spending was obviously a significant portion of the focus in the past 12 months. 

Social bonds really pick up categories that are again, not environmental, but we know have real societal benefit. That's something that up until now, because it's a little more difficult to quantify impact, had been underrepresented in the ESG markets. Up until last year, we saw green bonds issued at about a three to one multiple to social bonds, and the reason is that we had a lot of metrics that were quantitative, that we could rely upon for very credible impact metrics on the back of a green bond. We issue a green bond and we can measure that in environmental terms. It's a little bit harder with social bonds, and a little bit less clear. This year, for those of us on the issuer side, it was comforting to see investors getting comfortable with these social transactions coming to market.

Sonali Basak: Sean, when you speak to investors who are thinking about ESG, and want to put their money to work in impact, do you ever feel that you're competing against these different forces and interests? What are the conversations like that draw your clients into green versus other places?

Sean Kidney: People are interested first in their capital being used to do good, and one of the things we've proven over the last few years is that people that invest in these things actually do better than the mainstream. ESG works, the extra data points of old give you a greater prediction of sustainable returns. 

Now, the green and the social are part of that. The EU issuance of social bonds, some $30 billion AAA bonds, is actually working well for people. In the German market where the green bond has been issued at a slight discount to the primary market, they're actually performing eight basis points better in the secondary market than a vanilla bond. 

Investors know this, investors see this, and in the downturn, they hold their value so they're a capital retention tool going forward. This is one of the things driving it, but fundamentally, the customers of investors are saying, why can't I have my capital doing well while doing good? We have BlackRock responding to this in terms of climate change and recently Larry Fink's various letters on this topic, but they're not the only one. Funds around the world have been doing it and it's because it is doable. We can make money while doing good; green bonds have proven the point.

Sonali Basak: I'm so glad you brought up the financial aspect, because a lot of the questions around ESG is how to place the money and how to make sure that there is an impact as well as a return. As far as another point of measurement, to make this market advance further, what do we need to be measuring better than we have had before?

Sean Kidney: One of the things we've talked about is the need to make it easy for people to understand what the right kinds of investments are, and we've done that with something called a taxonomy. It's now become part of the European regulatory landscape to bring in a taxonomy of definitions for sustainable investments. We're trying to make it easy for the market to go forward. 

Critical to all of this is this idea that when we get to green investments in the green space, we must be addressing the Paris Agreement; it's a clear underlying requirement of the whole market. And in the social space, it's actually regulated as well. The European investment, the European Commission's $30 billion of SURE bonds, in the European Union are linked both to the recovery of the pandemic, but also the building of resilience. The $750 billion European Resilience And Recovery Fund demands that member states actually look at what they're doing to create resilience. Guidance is becoming a norm. Central banks are adopting this guidance. Christine Lagarde at the European Central Bank is going to do green Quantitative Easing based on taxonomy. We're making it easy.

Sonali Basak: When you look at your investment opportunities around the world, you do see more governments and central banks starting to take action and work together. Deborah, how does this change your calculus? What do you need to see, and how does it make it difficult to invest in some areas versus others, like the United States, that have changed its course on the Paris Agreement in the last couple of years—and maybe reversing now?

Deborah Ng: Ontario Teachers is a very long‐term investor. We have members with pensions that are going to contribute to the pensions for 30 years, and they're going to be  retired for 30 years. While we've been heartened by the amount of countries that have been committing to net zero—50 percent of the countries by GDP and by emissions have committed to net zero—that gives us a lot more ammunition when we go out there and look for investments in climate technology. Then, where the risk comes of course, is not being able to rely on having stable long-term climate policies. As a long‐term investor, we also have to consider the likelihood for a country that we're investing in to change their policy or scale back on a climate, because that is going to impact the value of our investment.

Sonali Basak: I covered investors and banks for a number of years here at Bloomberg and they keep saying that Europe has been more consistent, and that this is a much bigger market in Europe. Amy, when you're talking to investors, what does it mean for them to have that kind of lead? What would it take for other regions to catch up?

Amy West: The point made by Deborah was a good one. Consistency of regulatory support and the political will to have that consistency is something that we haven't seen for the past four to five years in the US. From the perspective of going forward, the US rejoining the Paris Climate Accord and COP26 are going to be transformational. Interestingly, we’ve already seen a lot of interest out of North American investors in ESG, for two reasons. A lot of the global investors that happened to be US domiciled funds already are significant investors in other markets, where this is the law of the land. And, if you're a big global investor, you don't traditionally go to the jurisdiction with the most lax requirements and implement that policy, you usually implement the more stringent policy. Once you understand how to implement as an investor, it gives you a competitive advantage. 

In my opinion, investors in the US that engaged in ESG have not done so because of regulatory reasons, they've done so because of capitalist reasons. And, in some ways, I think on a longer term scale that will position them well for success. It's rare that you consistently see governments lead innovation. The private sector throughout history has traditionally led on innovation, and I don't expect this to be different. It's fabulous that the consistent regulatory environment in Europe has created a breeding ground for the private sector, but it's a careful balance between doing that and stifling innovation.

Sonali Basak: Sean, are we moving fast enough?

Sean Kidney: Well, patently not. That's why we're getting climate impacts around the world now. That's why the Arctic and Northern Canada is warming at an unbelievable level. In fact, if you look at the cold that we're experiencing in the US at the moment, it's because the Arctic is too warm and it's pushing cold air down. 

We've got about a trillion dollars going into the right kind of investments. It needs to be $5-$7 trillion a year, so the scale we have to achieve is way above where we are now. A lot of that will be redirecting capital flows. If you're investing in transport, stop investing in freeways, invest in mass transit. 

The good news is that there is capital moving and we see the demand being unquenchable for the kind of capital. The other good news is that we have countries moving, 110 countries have committed to 2050 net zero targets, and the US looks like it's about to. Europe has also committed to 20%, 30%, 55% cuts, and that's what the whole world needs to do; the target settings are coming together this year in a way they were not pre-pandemic. We've got to deliver, and that's going to mean some very tough decisions about industrial policy. This will create jobs and the kinds of investments we need to make in terms of shifting our economies will create a 30 year boom. We've got to get going and start investing.

Sonali Basak: Speaking of investing, we were getting this question from the audience now, from an investors perspective, what does a company need to consider when they're making a net zero commitment?

Sean Kidney: Is the change strategy they're looking at commensurate with what we actually need to do? That's the key thing. It's hard if you're a company, because you've got to shift your business lines but there's opportunities. In the steel industry, for example, you need to be looking at a shift to recycling, electric arc furnaces and usage for green hydrogen. Green hydrogen will be the same price as gas in 10 years time, so if you get going on that pathway you will be able to make the transition in a really solid time. In cement, there are low carbon concretes, at the same price, already being offered by LaFarge, Heidelberg and so on. But we've got to scale that up, and we need help from the government on procurement policy to make sure those things grow, etc. 

If you're a company, look at what the envelope looks like and where you've got to change. It may require you to talk to the authorities about energy policy or property policy as part of making that change. There's no doubt that the public sector working with the private sector has to be a theme of making this change going forward.

Sonali Basak: Deborah, for a country with such a huge energy industry, how do you balance the Road To Net Zero with that reality?

Deborah Ng: It's about long range planning, and as Sean said, it’s about ambition setting that roadmap. To get there, you have to map it out. We need to think about it in a way that is just as orderly because it's going to be very disruptive for certain sectors. I think a lot of the energy-intensive resource companies in Canada have been making progress. They have been trying to make their operations more efficient and it is a very well‐regulated industry in Canada. 

We really need to think about it as a country strategically and then set that roadmap there. We're looking at our 2030 targets now, and how that's going to be implemented.

Sonali Basak: You act on behalf of retirees at such a major retirement pension plan. Is there a frustration about moving fast enough or is there a greater concern here about what the job outlook looks like as this transition happens?

Deborah Ng: I think how fast his transition happens has a direct bearing on the pension plan and our ability to earn returns. We are a global investor, and we are exposed to the global economy for a very long period of time. We don't have the luxury as a company to manage our own operations and get to net zero, but as a pension plan with 3000 investments, we have to get all of those investments to net zero. For us, time is of the essence, we have a lot of work ahead and every investor needs to get started on that pathway now. If we don't make net zero by 2050, we are going to have some serious problems ahead of us.

Sonali Basak: Amy, what do they need to see from companies? From an investors perspective, what do companies need to be doing as they make these commitments?

Amy West: From the issuers to the investors, transparency is going to be key, because how we actually calculate emissions is largely undefined right now. There is no agreed upon methodology that every company is going to do. 

Some of our most informed investors and issuers both know this, so transparency around how you're calculating your emissions is going to be key. I also think understanding that not every single industry today is going to be able to transition. On the other hand, there's some industries and sectors that will probably be able to go net-negative. 

I'd agree with Deborah's comments, because I work for Canadia Bank and we are very active in Canadia in this investment space…. When we look at net zero, each industry approaches it a little different. I think that investors asking for transparency, clarity, and information are making reasonable requests. It's not about stopping to bank or stopping to invest in some sectors or another; I think the days of negative screening are long gone. It's more, how do we figure out the outperformers from the underperformers in this transition?