Analysis: The state of play for sovereign green bonds as governments line up

There are at least 10 governments currently considering issuing labelled green bonds.

Portugal, Ireland and Italy are the latest governments to confirm they are looking at issuing sovereign green bonds, fuelling excitement about the potential for the asset class to help countries finance their climate commitments.

The sovereign green bond market only kicked off seven months ago, when Poland launched the first deal in December, but its prospects have already generated massive levels of attention. The interim recommendations from Europe’s High Level Expert Group on Sustainable Finance (HLEG) suggest the European Commission should be proactive on helping EU member states tap the market.

France demonstrated the potential liquidity that government issuers can bring when it sold €7.2bn of 22-year green notes in January – the longest-dated in the market so far. It was the biggest green bond ever issued, and still saw its order book more than three-times oversubscribed. It has already completed a second tap, selling a further €1.632bn at auction last month.

“We beat all the records we had for a syndication with a €7bn print, and the €23bn order book was at that time the most impressive we’d had,” said Anthony Requin, Chief Executive of Agence France Trésor (AFT). “There were 208 [investors] in the book – twice the number we had the year before in our [non-green] 20-year benchmark. So it was a great success.”

According to a number of market participants, there are at least 10 other governments currently considering issuing labelled green bonds. Most recently, government officials from Portugal, Italy and Ireland confirmed they were eyeing the market. Others understood to have expressed interest include India, Bangladesh, Austria, Japan, Sweden, Australia, China, Fiji, Zimbabwe and Nigeria.

But despite all the talk, countries are proving slow to act. Nigeria was expected to come to market earlier this year, in a high-profile deal endorsed by the country’s former Environment Minister – now UN Deputy Secretary General – Amina Mohammed. However, the transaction was postponed due to broader budgetary delays, and RI understands it is now expected to be a smaller deal than previously expected and is slated for next month.
Bankers say it is hard to make the case for sovereign green bonds for a number of reasons.

Ring-fencing proceeds and minimising political risk

There are two characteristics specific to sovereign issuers, which both present some reputational risk for investors. Firstly, governments often have a legal requirement to run their money through a single account, meaning they cannot ring fence capital for specific projects.
Until June, the Green Bond Principles (GBPs) stated that “the net proceeds of the green bonds should be credited to a sub-account, moved to a sub-portfolio or otherwise tracked by the issuer in an appropriate manner”.

“When I look at the pillars of the Green Bond Principles, the one I find sovereign issuers are most struggling with is about the management of proceeds,” said one leading green bond investor, who asked not to be named. “To be honest, I’d rather see issuers take this less literally than be held back by it. There needs to be a clear system to earmark proceeds, but that could just be a spreadsheet – there doesn’t need to be a bank vault somewhere with the green bond proceeds in it. What investors are looking for is a way to track the money, and it needs to be trustworthy and suitable for external auditing.”

Other members of the GBPs seem to agree, and last month the body updated the statement to clarify: “the net proceeds of the green bond, or an amount equal to these net proceeds…” This is aimed at enabling sovereign (and some corporate issuers) to address the issue of not being able to segregate funds.This fungibility also makes proceeds vulnerable to changes in government because there is no mechanism to ensure new leaders honour the environmental commitments of a green bond framework created before they took power. These swings in the political agenda have been brought to the fore by Donald Trump in recent months, who has begun the process of unravelling all the formal climate commitments made by Barrack Obama. In principle, the same thing could happen with a sovereign green bond, and investors could find their money being directed into non-green initiatives with little recourse.

The French government overcame this by creating an independent committee dedicated to allocating the proceeds of the green bond. The committee will remain in place regardless of the government. “This is a move in the right direction in terms of protecting green investors from changes in a country’s ideology,” says one unidentified investor. “But we were disappointed with France because we wanted to see details on who was going to be on the committee before the bond was issued, not afterwards. It’s hard for an investor to tell how robust it will be in ensuring the proceeds are protected. We want to know that the members have environmental expertise and independence from the political system.”

The issuer’s ESG profile

More familiar issues have also raised their head for sovereign issuers. Namely, the perennial questions of what counts as ‘green’, and the legitimacy of green bonds from issuers with poor environmental profiles. Arguably, no issuer has highlighted the long-standing tension between issuer and bond more than Poland, which faced a mixed reception when it came to market with a €750m labelled deal in December. With an economy built on coal, and a reputation for being one of the most obstructive European countries in relation to wider climate change efforts like the development of the EU Emissions Trading System, Poland showed uncharacteristic environmental leadership with its deal, and became the world’s first sovereign green bond issuer.
“Poland was a good example of a government trying to use a green bond to meet some of its national climate targets,” explains Yo Takatsuki, Associate Director of Governance and Sustainable Finance at BMO Global Asset Management, which bought the notes for its dedicated green bond mandates. “It’s a country that’s been reliant on coal, so it was an encouraging sign of movement.”
BNP Paribas Asset Management did not participate in the deal, however, citing the green credentials of the projects being financed. Proceeds are to be used, in part, to electrify some the remaining 60% of Poland’s railway lines that still run on diesel. Senior SRI Analyst, Felipe Gordillo, says that on the roadshow he challenged the Polish delegation “to explain how this railway renovation will be climate-aligned”, given that electricity in Poland is generated mostly by coal-fired power plants. “Reducing Scope 1 emissions to increase Scope 2 emissions is not positive for the environment,” he says, adding: “They provided no explanation of their impact assessment modelling to alleviate our concerns about the climate benefit of this green bond.”
But Justine Leigh Bell, Director of Market Development at the Climate Bonds Initiative says the Polish bond should be seen in the broader context of the green transition. “The point about electrification in a coal-based economy is valid, but we cannot wait for every stage in the transition of an economy to renewables before we roll out electric vehicles – we need them quickly and on a mass scale.”

France’s bond, on the other hand, had “lots of opex” [operational expenditure], points out Leigh Bell. This is an aspect that has garnered criticism for the French government as, traditionally, green bonds are expected to finance hard assets. This is often preferred by investors because of the clear outcomes, and the issuer’s ability to impact report effectively. It’s a tough one for governments, as the role of states in greening economies is often through the ‘soft’, intangible programmes, like tax breaks, research and development and subsidies.
To make it easier for sovereigns to issue green bonds that are more aligned with this softer approach, the GBPs were also amended last month to describe eligible green projects as “including other related and supporting expenditures, such as R&D”.


The capacity for green bonds to finance projects that otherwise wouldn’t secure funding is a long-raging debate, with some hoping that sovereigns may be the first issuers with the financial discretion to use proceeds for new initiatives and innovation, rather than simply repackaging existing investment strategies. However, this is not playing out so far, according to some. Rhys Petheram, a fixed-income fund manager at London-based Jupiter Asset Management, buys green bonds for its mixed asset Global Ecology Diversified fund, but he didn’t take France’s notes. “We could get comfortable with the French bond not ring-fencing proceeds, and we could get comfortable with them financing projects like tax breaks – although neither is ideal. But what we couldn’t get comfortable with was the fact that some of those projects had been done historically.France needed to issue a green bond that was big enough to be in line with its other bonds, and that means it had to include historic green projects too, to bring it to scale. That raises a question around how much impact that money is actually having.”

The AFT’s Requin concedes that, even for the new projects, France could have just as easily financed its green spending through its normal OAT programme – green bonds didn’t allow it to finance more.

“But you can quite easily imagine that if in the first place we have not increased the amount of capital being allocated to green projects, you might in future have an environment minister that could think about funding a huge investment plan thanks to this proven ability of the debt capital markets. So it’s just a matter of time on the political clock, and of budget capacity, before a new investment plan including green assets will be financed by sovereign green bonds,” he explained. “And there you will find the additionality.”

So what’s the point?

It’s an asset class that requires more time and effort to issue than conventional sovereign bonds; where a country’s broader environmental profile and the projects it wants to finance risk coming under scrutiny; and where there is no pricing benefit. So what’s the motivation? Requin says the French state didn’t issue a labelled deal for financial reasons: “The desire was to demonstrate that capital markets can be a tool to help states, wherever in the world, finance their energy transition. After our transaction, I can say that it was a nice experience, and I invite other governments to follow.”