investment viewpoints

    Climate bonds: investing with impact in the race to net zero

    Climate bonds: investing with impact in the race to net zero
    Thomas Höhne-Sparborth, PhD - Head of Sustainability Research

    Thomas Höhne-Sparborth, PhD

    Head of Sustainability Research
    Christopher Kaminker, PhD - Group Head of Sustainable Investment Research, Strategy & Stewardship

    Christopher Kaminker, PhD

    Group Head of Sustainable Investment Research, Strategy & Stewardship
    Erika Karolina Wranegard - Portfolio Manager, Fixed Income

    Erika Karolina Wranegard

    Portfolio Manager, Fixed Income

    Climate change is a defining challenge of this generation.

    Over the next years, investment in climate mitigation and adaptation needs to be scaled up drastically. Investment requirements in the energy system alone are expected to increase to US$ 5 trillion per year by 2030, up from just over US$ 2 trillion today1. Additional investment will be required in infrastructure, nature-based solutions, and the circular economy. But how do investors access these climate opportunities?

    Enter climate bonds. A growing and increasingly diverse climate-bond market could help meet the need for this impact capital. One vehicle focused on climate bonds is the Global Climate Bond strategy, launched in March 2017 through a strategic partnership between Lombard Odier Investment Managers (LOIM) and Affirmative Investment Management (AIM).

     

    Global Climate Bond: impact without compromise

    The strategy targets mainstream returns and does have an environmental and social impact2. It finances projects in areas like renewable energy, sustainable transport and climate-resilient infrastructure that mitigate or help adapt to the effects of climate change.

    The portfolio is aligned to the UN Sustainable Development Goals (SDGs) and the Paris Agreement. Still, we believe it’s important to go beyond alignment and measure and evidence the environmental and social outcomes arising from the investment. This is captured in the Global Climate Bond Impact Report.

    The report details how investors have supported efforts to mitigate climate change and promote resilience to its effects. In 2020, the strategy supported 2,330 such projects and initiatives—almost double of the previous year3, largely due to a significant rise in the AUM from last year.

     

    Impact-Highlights-2020-GIF.gif

     

    Portfolio allocations 

    Infrastructure, energy and water were the top three sectors where the impact bond proceeds were allocated. Infrastructure projects included clean transport networks, green buildings, resilience measures and information and communication technology. Buildings were the biggest beneficiary within infrastructure sector constituting a 44% share. 

    The portfolio also supported 15 of the 17 UN SDGs with the biggest allocation to goals of affordable and clean energy, sustainable cities and communities, and climate action. Mitigation-focused activities constituted 74% of the portfolio whilst 15% was allocated to adaptation-focused projects.
     

    In 2020, the top three sectors that impact bond proceeds were allocated to were environmentally focused.

    GCB---infrastructure.jpg

    51% Infrastructure

    Hard and soft infrastructure promoting inclusive, climate–resilient, low carbon built environment; for example, clean transport networks, green buildings, resilience measures, information and communication technology.

    Over 7,000 daily passenger capacity supported in low carbon transport.

    Over 23,000m2 of buildings (by floor area) constructed/refurbished to higher energy efficiency standards

    GCB---energy.jpg

    24% Energy

    Renewable energy generation, modern energy access, energy storage and energy efficiency technologies.

    215MW of renewable energy generation capacity supported

    GCB---water.jpg
    10% Water

    Water resources management, wastewater treatment, sanitation, water efficiency measures.

    Over 6 million m3 of wastewater treated annually

    Source: AIM Impact report 2020, For Illustrative purposes only

     

    Top portfolio components 


    GCB-report-2020---top-portfolio-components.png

    Source: AIM Impact report 2020, For Illustrative purposes only

     

    Quality versus quantity 

    Whilst quantitative measures of impact are important, not all impacts can be verified by numbers. Qualitative observations of impacts achieved complement the hard data and help show how we support several SDGs.  

    For instance, Burkina Faso, a landlocked country in West Africa, has one of the lowest electrification rates and the most expensive electricity costs within the region. To support the country in scaling up its electrification through solar energy, the FMO Entrepreneurial Development Bank4, a holding in our portfolio, is providing a loan to help finance the development and construction of the Kodeni solar project5

    The solar-power plant is expected to have an annual energy generation capacity of 67.2 GWh. This aligns with SDGs seven and eight – affordable and clean energy and climate action – and could help achieve the government’s target of increasing the nation’s electrification rate to 80%.

    Projects like these matter because the rapid scaling up of renewable energy capacity is essential to meet the world’s growing energy demands while reducing overall greenhouse gas emissions. Lack of access to electricity also hurts economic development and impacts people's health and wellbeing – making investments in renewables paramount.

    Similarly, power company Vattenfall’sHydrogen Breakthrough Ironmaking Technology project in Sweden is helping fund the production of the world’s first fossil-fuel-free steel by 20267, using green hydrogen and virtually no carbon footprint8. Steel currently accounts for 7% of global carbon emissions and a successful rollout of the project could result in cutting Sweden’s carbon emissions by 10%9.

     

    Other-Highlights-2020-GIF.gif

     

    Other key highlights of the impact report include:

    • 126,600 tons of greenhouse gas emissions avoided per year, equating to 70% emissions savings10, compared to a baseline derived from the IEA’s Stated Policies scenario, and calculated using the Carbon Yield® methodology co-developed by AIM
    • A coverage ratio of over 90%
    • Over 2,330 projects supported in over 160 countries, equating to three quarters of the globe
    • Weighted Average Carbon Intensity (WACI)11,12 of about 64 tCO2e/ US$m revenue versus 225 tCO2 e/US$m revenue for the benchmark Barclays Global Aggregate Bond Index, implying a 71% reduction in carbon intensity versus the benchmark

    The full report can be downloaded from the Global Climate Bond strategy page.

    sources

    1 IEA’s Net Zero by 2050 report, 2021.
    2 There can be no assurance that the sub-fund’s investment objective will be achieved or that there will be a return on capital or that a substantial loss will not be incurred.
    Global Climate Bond Impact Report 2019 showed 1,350 projects/initiatives were partially or fully supported by impact bonds held in the portfolio.
    4 Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document.
    5 FMO (2021), Sustainability Bonds Newsletter
    Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document
    SSAB, Timeline for HYBRIT and fossil-free steel
    Vattenfall (2021), Green bond investor report March 2021
    Vattenfall (2021), Green bond investor report March 2021
    10 Calculations are based on project level scope 1& 2 emissions. The Greenhouse Gas Protocol defines Scope 1 emissions as direct emissions from company facilities and vehicles; Scope 2 emissions as indirect emissions related to purchased electricity, steam, heating and cooling used in company activities.
    11 The WACI should be regarded as an assessment of the carbon profile for the share of the portfolio covered by the analysis. The WACI was calculated by maintaining original portfolio weights. The same approach was used for the benchmark.
    12 Conducting an issuer-level GHG analysis on fixed income portfolios is a detailed exercise that does not currently benefit from the methodological standardisation and data availability that the equity space has. Moreover, the mapping of sub/supra-national securities and the selection of the most appropriate GHG emission intensity indicator for sovereign bonds are still matters for debate. We have adopted a conservative approach, accepting this may lead to overestimation of the carbon intensity of our portfolios. For example, given the lack of harmonised datasets for sub-national entities, we mapped sub-sovereign issuers to their respective country; for countries’ GHG emissions, territorial emissions were used, even though that might cause double-counting across asset classes. A simplified example of the potential double-counting is a portfolio comprising bonds issued by a corporate domiciled and operating in a country whose government bonds are also held in the same portfolio. The corporate issuer’s emissions arising from domestic sites would also be counted as part of the territorial emissions associated with government bonds issued by the country where the domestic sites are located. These approaches were necessary because of the lack of well-established alternatives.

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