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Introduction to Green Bonds


TOM BUTCHER: Fran, what are green bonds?


FRAN RODILOSSO: Green bonds are defined primarily by their use of proceeds, which must have a beneficial environmental impact. Green bonds are really no different from plain-vanilla bonds issued from the very same issuers. They are often identical in structure and definitely in seniority, which is to say that the vast majority of green bonds are not dependent upon the success of the projects for which they are issued for their repayment. They are dependent upon the full creditworthiness of the borrower in general. They represent a call on all of the borrower's cash flows, which is an interesting aspect. Green bonds come from a variety of issuers. Originally, supranational or multilateral organizations were the first to issue green bonds. Global banks, corporations in a variety of sectors, and more recently, sovereign issuers have tapped the green bond market. The use of proceeds, as I mentioned, must have a positive environmental impact or be environmentally beneficial, and can include clean energy-related products, efficient building structures, efficient or cleaner modes of transportation, related projects, or even mitigation- or adaptation-type projects. An adaptation, for example, would be something that combats the irreversible effects of climate change.


BUTCHER: Ed, why consider a green bond ETF?


ED LOPEZ: First and foremost, an ETF is a really efficient way of accessing this market. The second key aspect is the green bonds market itself. We have seen tremendous growth in the green bonds market over the last couple of years. Currently, there is approximately $146 billion of labeled green bonds outstanding. In 2014, issuance tripled; it then doubled in 2015 and again in 2016. It is anticipated that we could see issuance of up to $150 billion in 2017. What is driving all of this interest in green bonds? You might trace this all back to 1994 and the first United Nations Framework Convention on Climate Change (UNFCCC), and then all the subsequent conventions the UN has had since. This work culminated in the Paris Climate Change Conference in 2015, which brought forth the Paris Agreement, where parties proposed their plans to help and to try to limit climate change and the temperature rise to 2° Celsius. In order to achieve this target, some estimates are that we will need close to $100 trillion of investment across the global economy by the year 2030. That is nearly the same size as the global bond market is today, green or not. Investor participation is going to be critical. What you see happening now are regulations and incentives being developed at the local level to help support this initiative, whether it is states like California, or countries like China or France. You are also seeing, for green bonds in particular, the development of specific standards around issuance and verification.


This should help support ongoing investment in the space, as well. We are moving towards a common set of standards that the market has agreed to, called the green bond principles. Groups such as the CBI, or the Climate Bonds Initiatives, are helping to lead the way.


BUTCHER: Thank you. Fran, what does the investable green bond market look like?


RODILOSSO: The investable market, when you aggregate it, is still relatively small, but it is quite diverse. Overall, it looks like a global bond portfolio. As we mentioned earlier, these bonds are very much like plain-vanilla bonds, in terms of their seniority, and in terms of yield and duration. There has not been a very detectable give up in yield for investors, for instance. You end up with a geographically diverse portfolio that is similar in yield and duration to many global bond portfolios. The S&P Green Bond Select Index that we are following is quite high quality. About 95% of the issues in that Index are investment-grade, and more than 50% are AA-rated or higher. It's geographically diverse. The Index has multi-currency exposure, with about 85% of its currency exposure to the euro and U.S. dollar, and at least half a dozen other currencies represented. It is diverse with regard to issuers. As I mentioned earlier, green bonds come from supranational or multilateral organizations, banks, corporations, and sovereigns. To give you an example of some of the issuers in this Index, they are the same types of issuers you might see in a global bond portfolio. On the supranational side, the European Investment Bank was one of the early players in the green bonds market. On the corporate side, Apple did an issue last year; it was about a 1.5 billion U.S. dollar seven-year issue Apple launched in 2016. It includes multiple uses of proceeds along the lines of using renewable energy, conserving valuable resources, and making their processes more efficient. The government of France, this year in early January issued the largest sovereign green bond ever. It does not mature until 2039 – and represents the longest maturity green bond issued. It was issues for multiple green purposes, to help France meet its obligations under the Paris Agreement.


LOPEZ: Tom, one of the questions that we often get asked when we launch an ETF is, how do I use this ETF in my portfolio? I think, for many reasons and characteristics that Fran talked about, incorporating green bonds into your portfolio is quite straightforward. Green bonds are essentially standard bonds, with the stated purpose of being green. In this case, being green just happens to be a bonus. Given the current makeup of the market, it may fit very well in a core global bond allocation in a portfolio.


You don't have to be an ESG investor to make this work. Even if you just happen to think ESG investing is mportant, its yield and duration characteristics are similar to other bonds in your global portfolio.


BUTCHER: Right.


RODILOSSO: Which is great. You're not necessarily giving up yield or adding risk -- at least in a portfolio of the same issuers, you're not adding credit risk by going green, and you're getting the same yield, or similar yield, out of the portfolio. I think that's an important point.


LOPEZ: Yes, I think investors can earn income and still make an impact.


BUTCHER: Thank you both for joining me.


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