Bond markets are shaping up to be the new climate vigilantes. Surging demand for sustainable funds and new European Union rules will make debt investors more wary of buying securities issued by polluters. Pushy lenders, more so than shareholders, should be a powerful spur for companies to go green.
Corporate bond investors have been a laggard in the green revolution. Low central bank rates mean fund managers’ chief concern is finding securities that offer any yield. Rating agencies are starting to pay more attention to climate risks in their assessments, as S&P Global warned on Tuesday, but they still currently assign high grades to many polluters.
The market, however, is becoming more discerning. Corporate bond funds labelled as sustainable are growing quickly. Those denominated in euros more than doubled to $48 billion between the end of 2018 and November 2020, Morningstar reckons. Investments are getting more sophisticated. Tabula, a provider of exchange-traded funds, recently launched a new product that allows investors to only buy bonds issued by companies that align their business with Paris climate goals.
Meanwhile, asset managers will this year have to show how sustainability factors influence investment decisions and returns. While those rules only apply to EU groups, they will also force companies that want to compete in Europe’s 25 trillion euro asset management sector to comply. The Bank of England and the European Central Bank, which own 280 billion euros of corporate debt through money-printing programmes, are now under pressure to cut exposure to polluters.
The trend may already be impacting company funding costs. Take Exxon Mobil, one of the more creditworthy debt issuers. It’s currently AA rated by S&P, but a relative climate laggard. Exxon’s euro-denominated bond maturing in 2028 now yields roughly 20 basis points more than equivalent securities issued by lower-rated Total, which has renewable generation and emissions reduction targets. Back in July last year the difference was minimal.
The direction may not always be one way. With oil prices likely to rise, polluters’ bonds could yet appreciate too. Low interest rates mean few companies are in danger of being shut out of markets altogether. However, bond markets have real power. Whereas companies issue equity rarely, they need to raise debt frequently. That makes credit investors the ideal vigilantes.