Thursday 12 November 2020 4:55 am

Green Bonds are misguided, counter-productive, and an investment handicap

Bill Blain is market strategist and head of alternative assets at Shard Capital. He writes a daily market commentary called The Morning Porridge

On Monday, the chancellor announced that the UK government will soon be issuing “Green Bonds”.

In separate but related news, Scottish Widows will dump £400m of stocks that don’t meet Environment, Social and Governance (ESG) criteria. ESG compliance has become the first thing discussed at investment committee meetings. Everyone wants to show how green they are. 

Does it make any investment sense? Will Green Bonds and ESG investment criteria improve the efficiency of capital, save the planet, and make the world a better place?

Probably not.

ESG is a fine concept, but it’s basically common sense. Any competent fund manager shouldn’t need to be told to avoid firms that are badly managed, don’t care about staff or customers, promote dangerous products, or don’t ensure their long-term sustainability by trying not to pollute the planet. 

Similarly, a smart investor might identify what appears to be an environmental red flag but upon closer examination conclude that the company’s overall approach to solving a negative is actually a positive investment factor.

In contrast, wrapping ESG “compliance” around investments stops any chance of finding work-arounds. It has already become a straightjacket — generating bureaucratic sludge, stifling investment decisions, and acting in much the same way as overly officious regulation.

Let me give you an example.

I’ve been trying to finance a new coal mine in the UK. I was careful to explain that it was Metallurgical Coal — the critical ingredient that turns iron into steel. It’s nothing like thermal coal. In fact, it is classed as a strategic resource in the EU. I ran through the environmental benefits: digging it here in the UK is much cheaper than importing it from Australia and would save billions of carbon miles. Nonetheless, 90 per cent of investors switched off the moment I uttered the word “coal”, because it would fail their ESG criteria.

The new mine has been designed to be green from the start. It would reduce the cost of steel for wind farms, solar power arrays and renewable power. It would create 500 good jobs in a severely depressed part of the UK. The project’s management included the smartest miners in the UK. The deal ticked each one of the E, S and G boxes convincingly.

No one in London was interested. “ESG Says No,” they all said.

I finally found an external investor who got past the ESG mumbo-jumbo. They understood the transaction. They loved it. It made sound financial — and ethical — sense.

Unfortunately, the deal is still in abeyance. Despite the full support of local politicians, MPs and the bulk of the local population, it was put on review by a government which apparently doesn’t want to start a fight with Extinction Rebellion protestors. Without clear government support, the investor pulled out.

The government behaved exactly like ESG investors: unwilling to question the underlying “E” narrative, regardless of the facts. The UK’s good coal will remain in the ground, 500 people will remain on the dole queue, steel will be more expensive, and ore carriers will pump thousands of tonnes of CO2 into the atmosphere bringing Metallurgical Coal to Europe.

Overly simplistic labels do not work. In fact, they stifle investment innovation. Every credit manager wants AAA — and remember how well that worked in 2008. Every investment firm is now falling over itself to demonstrate how green and ESG-focused it is, even though no one quite agrees on what these nebulous concepts might actually mean. 

The result is that ESG instruments command a premium over non-ESG securities. The price goes up and the return goes down. And because there is still no agreement on what a Green Bond or ESG means, the incentive to greenwash — to pretend a business is green and ESG compliant — increases.

Rishi Sunak has now jumped on the Green Bond bandwagon. He thinks the launch of the UK’s own “Green Gilt” is terribly exciting. He says it will attract new classes of investors, boost public and private debt markets for green companies, and demonstrate the UK’s leadership in environmental protection, or some such nonsense. It might even make them cheaper to finance — because they are scarce and cosmetic, Germany’s Green Bunds trade at premium to conventional Bunds.

I am sure it will make pensioners ecstatically happy to know that their pension provider has bought these Green Gilts rather than these nasty horrible Brown Gilts — right up to the moment they find their pension payments falling because it turns out shiny new ESG investments yield less than their non-greenwashed peers.

Main image credit: Getty

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