ESG Bonds Amar Jandoo

‘ESG’, short for ‘Environmental, Social and Governance’, is an acronym most will be familiar with by now. Local authorities may typically associate this with investment strategies and how a portfolio can be made more responsible in its underlying holdings. But how about ESG compliant funding?

An ESG bond, which would include ‘green bonds’, is an instrument used to fund projects which have a positive impact on the environment, social issues and/or governance. There has been a growing demand from private institutions to buy ESG related assets as investors become more aware and conscious of their holdings.

Local authorities are an attractive borrower to these lenders as most public services provided have a strong ESG overlay. For example, energy efficient housing and sustainable waste management satisfies the ‘environmental’ element, care homes and leisure centres fit the ‘social’ element, and local authority management, transparency and reporting provide the ‘governance’ section.

The Municipal Bonds Agency recently announced it plans to issue ESG bonds on behalf of local authorities. The framework is expected to be aligned to the initiatives like the ‘Green Bond Principles’; these are voluntary process guidelines which recommend transparency and disclosure and promote integrity in the development of the green bond market. The MBA endeavour to keep the process as simple as possible for local authorities, by having a standard approach which uses publicly available information, therefore not requiring a separate reporting regime.

Sir Merrick Cockell, Chairman of the UK MBA, was a recent speaker on Arlingclose’s Trending Treasury webcast, where he described the vision for the ESG framework: “We want to make it as simple as possible, and that means majority of the responsibility for evaluating projects, managing that information and reporting it back to investors, and independent verification will rest with the Bond Agency.” Merrick went on to say: “Local government wouldn’t need to hold funds in a segregated account, it would just form part of its capital programme”. You can listen to the full webcast here.

The MBA has also confirmed that the framework will be descriptive in setting out exactly which projects will and will not qualify under the ESG approved criteria. Projects with an ESG qualifying process will be considered, as well as those offering an end service with an ESG overlay.

There is also flexibility on the structure of funding available, as the MBA aims to tailor the funding process to individual needs. Single issue bonds will require a minimum size of £150m, however club issues are an alternative for those authorities with smaller requirements. As per the MBA’s conditions, club issues are subject to a proportional guarantee, therefore authorities will need to be comfortable guaranteeing a proportion of their peers’ debt.

Will local authorities be able to issue ESG bonds at lower rates than the PWLB? This will depend on a range of factors, including authority credit strength, issue size, duration and market condition. It will also be interesting to gauge how much of a discount, in terms of yield at issue, a specific ESG bond trades at, relative to a ‘standard’ local authority bond.

We believe there is opportunity for ESG bonds to provide additional competition within the alternative funding market which could undercut PWLB margins, and the growing demand from investors makes this an interesting proposition.

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