Jane: [00:08] Hello and welcome to the LSEG Sustainable Growth podcast, where we talk to leading experts about sustainability and finance and pretty much everything in between. I'm your host, Jane Goodland, and this week we're talking about sustainable bonds. And to help us get under the skin of this topic, I'm joined by Shrey Kohli, who's the head of debt capital markets at the London Stock Exchange. He's also the chair of the High Level Working Group on Green and Sustainable Sukuk, which is part of the Global Ethical Finance Initiative, aka GEFI. So we're in very good hands. But before we hear from Shrey, a very quick reminder to follow us and rate us on Spotify, Apple Podcasts or any other platform you use. Enjoy the show.
Jane: [00:53] Well hello Shrey and thank you so much for joining us on the LSEG Sustainable Growth Podcast. Do you know what? I feel as if it's been too long, you should have been on the show before now, so apologies it's taken this long, but I am really excited, actually, for this conversation because there's so many questions I have about the London sustainable bond market. So let's get straight to it. It's the 10th anniversary of the London Sustainable Bond Market this year. And so what I thought would be quite good to start with is, can you give us a bit of a potted history of this part of the market and how sustainable bonds have really grown up?
Shrey: [01:30] Yeah, absolutely. I mean, ten years. Can't believe it. How time flies.
Jane: [01:37] You don’t look old enough by the way.
Shrey: [01:40] I normally have some facial hair when I want to look a bit older, but that being said, I mean, when you think about it being a decade, it feels like quite the achievement. But it's been a journey that we at the London Stock Exchange have been on together with the market. So it's been ten years since we set up the sustainable bond market. Initially, it was just the green bond segments. That's because 11 years ago, the market came up with what was then called the Green Bond principles, which then turned into the sustainability bond principles. And a few more years before that, I mean, we're nearly reaching 20 years. You saw the forebearers of green bonds and social bonds emerge in the market. And depending on who you give a phone call to, it's either the World Bank, the European Investment Bank, the International Finance Facility for immunisation, or the Vaccine Alliance, which claimed their stake to being the first. So look, I mean, I would say the market is in its teenage years and we've been there for about ten. But as an exchange, I think it serves very close to our purpose of helping capital go from investors who want to return to companies that need the capital in service of an objective. So the sustainable bond market is now over 500 bonds, over 350 billion active on our markets with issuers from across the world, whether it's developing markets, emerging markets, sovereigns, banks, corporates, you name it. So it's a very vibrant community that we have.
Jane: [03:04] Excellent. So you touched on kind of the size there. And I do want to get a sense of the scale of sustainable bonds, not just in London but kind of globally. How much of the debt market are we talking about here? Is it material, and what sort of volumes are we seeing?
Shrey: [03:19] Yeah. So I mean numbers always need some context, right? So let's start with the overall market. So the number of sustainable bonds of different flavours that have been issued since they started being issued about 20 years ago is now nearly $6 trillion. There are nearly $5 trillion of these bonds still active. So it's still a market which has a lot of what's called notional outstanding. Obviously this went on its own curve. It was smaller to start with, but since about 2019-2020, you've seen about anywhere between 800 billion to about $1 trillion being issued every year. And to give you context, the global IPO market normally ranges about 150 billion to 200 billion in size. So what we're talking about is a scale of about 4 to 6 times the global IPO market. And that's not just the IPO market. It's the global IPO market.
Jane: [04:11] So that's really interesting when you compare the debt market to the equity market, it really gives a sense of the significant scale of this part of the market.
Shrey: [04:22] Yeah. And look, I mean, it's the context of the debt side of the balance sheet and the equity side of the balance sheet. I mean, debt markets annually. You see about $8 trillion issued anyways. So if you look at green bonds and their cousins within the sustainability bond market, you're about 10% to 15% every year, which is not small, but it isn't the majority of issuance you see within debt markets anyways. And with a wave of refinancing coming up, particularly from carbon-intensive industries, I think the future is one where we will see more issuance within this asset class.
Jane: [04:59] It's actually a lot bigger than I thought it was in percentage terms. So, that's an interesting statistic. So let's look at the London sustainable bond market, because I know that there are a number of segments. So we've got categories or segments around green, around sustainable, around transition. And also one that we don't talk about much, which is around social. So perhaps you can just pull out a couple of your favourites and tell us more about kind of what tends to be within those categories.
Shrey: [05:28] Yeah. So one of my favourite people in this market is a gentleman called Sean Kidney. Sean heads up the Climate Bonds initiative, and it's one of the nonprofits that's been there since the start of the market. Sean describes this as the 21 flavours of green bonds. Which is kind of the situation that we're in right now. It's like an investor going into an ice cream store and trying to figure out where their funding is going or what impact they would have. So when you go to an ice cream store, you say milkshake or ice cream or cup or cone. I think I start off with the main type of sustainability bonds nowadays are the bonds where your money is going to, or the issuer tells you where your money is going to, or what we call use of proceeds bonds. So these are the likes of green bonds where the projects are effectively projects which are going towards the funding of renewable energy or climate change adaptation overall or climate change mitigation and resilience, or green buildings. And a number of the bonds that we've seen or the large component of the market is the green bond market, because, of course, climate is one of the most significant issues that we're facing with. One of my favourite issuances was working with the government of Fiji in sort of 2017, soon after the Paris Agreement, where the country was hit by a significant weather event and wanted to mobilise funding from international investors for climate change resilience.
It was the first emerging markets green bond and that was listed on the LSE sustainable bond market. Then there are social bonds and again it says what it does on the tin. The projects are sort of social enabling projects. And by that I mean access to education, access to healthcare, access to basic infrastructure. And this market really became vibrant during Covid, where effective access to basic infrastructure, healthcare became a core part of our needs. The African Development Bank did one of the largest social bonds at that time, along with the other multilateral development banks. NatWest has a social bond program. Sustainability is a composite of both. And then another flavour of it is not where the projects are going to, but what impact the bonds are expected to have. And these are the so-called sustainability-linked bonds. So there'll be an issuer, for example, a sovereign issuer that tells you what its carbon dioxide emissions trajectory is looking like in the future, or what its natural forestry covers looking like in the future. So I think that's a potted set of segments that we have on our market and really resembles what the market has become globally.
Jane: [07:55] That's really interesting, and I think it does reflect the really broad nature of sustainable finance in terms of it's a very sort of broad church in a way, isn't it, in terms of both the issues which are kind of included within that umbrella, but also the mechanisms that are in play. And effectively what some of the solutions or some of the challenges that we're trying to address. And I should imagine that adaptation and climate adaptation might be something which would be sort of forming part and parcel of the funding requirements, particularly going forward. So okay, so we've got an ice cream shop. It's called a sustainable bond market. And we've got lots of different flavours in there. So obviously, the question that a lot of people have around these types of bonds is their financial performance. So what's their financial kind of profile like? You know, which kind of goes to the heart of why you'd have these bonds. So I mean, we hear sometimes about the premium, can you break that down for us a bit and tell us what it is? And actually, does it really exist?
Shrey: [09:00] Yeah. So I think one of the great things about our jobs is that we spend a lot of time talking to treasurers or people who are responsible for the cost of funding for a sovereign, a bank or a company. And the first thing that if you ever speak to a treasurer is that there are conservative professionals as a whole because they're effectively the vanguards of someone's balance sheet. What they're looking for is the lowest cost of funding as their stewardship responsibility towards their whichever organisation they're working towards. So, as with most questions, the answer is on pricing, it's complicated. But you know one of the fundamentals of financial instruments is better data leads to better pricing which leads to better outcomes. So ultimately what a green bond is doing is telling your investors where your money is going towards. And in telling your investors what your money is going towards, you are doing better in terms of the governance that you have internally within your firm. The way that you plan your business going forward, looking at strategic elements which have a fundamental impact on your strategy. You are engaging better with your investors from a stewardship perspective.
And as a result, you are a better managed company. Now, what that leads to is sometimes in the primary market, a stronger demand for green bonds and therefore a better pricing, which is the so-called green room. But I often caution treasurers, when we speak to them, to say, that's not the objective over here. The objective over here is everything else that I described just before getting into what the price is. Ultimately, the investors all over the world that are looking for impact, right. Which means these securities are more scarce than conventional green bonds. And that means better pricing in the primary or the bonds trade tighter in the secondary. And we've seen that often in the sovereign market. There's a really interesting case where Germany did a bond. They did a conventional bond, which wasn't green and a green bond at the same time. And the green bond price tighter. But again, you know, that’s not the end. That is an outcome of the entire process over here, which is to communicate to investors what your strategy is as a company.
Jane: [11:11] What I'm hearing is it's not a guaranteed outcome, but it could be an outcome of depending on kind of the demand that you're seeing from the investor community for those particular bonds, which I guess has got a lot to do with timing and many other factors. So interesting. Which leads me on to this kind of question around the why? You know, really exploring the motivations both on this, both sides of that transaction. So the issuer so the issuer who may be thinking about raising debt capital, and the investors who may be looking to invest, you know, one of the questions that I've been asked before, and I'm sure you'll do a much better job at answering than I did, which was, why bother, right? Because actually, an issuer could raise conventional debt. So what's in it for them? Why would they want to do this? So let's take the issuer side of the transaction first. Why would they want to do it?
Shrey: [12:04] Yeah. And fortunately, Jane, I spent some time with an issuer who does issue bonds on the LSE, now, funnily enough, the International Finance Corporation, which is part of the World Bank. And by the time I was there, it was a very practised issue of green bonds. So it was a mature issuer of green and social bonds. I think if you flip the question, and instead of asking why do a green bond, ask why not do a green bond? The answer is it's simpler to answer. So the only reason you wouldn't do a green bond is the cost associated with it. Because it is hard to bring your organisation together, separate your balance sheet. Identify what projects of yours are green projects or social projects, or a mix of both. Or tell your investors what trajectory your business is heading towards in terms of its CO2 emissions. Now, ten years ago, I would say that's hard work. Where we're sitting today, I would say it's essential. If you don't have that much of an understanding of your business when you're sitting in front of an investor, your peers are telling them those things. So the question is, why wouldn't you go through the exercise where you cleanse your balance sheet and look at what you're funding? I think the second point is now that the financial industry has developed around green bonds, the act of issuing a green bond or a social bond or a sustainability-linked bond helps you get eligibility for certain indices as well. So there's a passive flow through ETFs, which now could act as additional investors diversifying your balance sheet. So again, to your point of you know what the job of a treasurer is. It's to ensure your lowest cost of funding. Diversification of your investors is one part of it. So, therefore, I mean, it's important for you to at least consider issuing a green bond as part of your funding mix. And if you don't, then explain why your conventional funding sources are sufficient to investors.
Jane: [13:52] So the question I have is, could all companies issue a green bond, or is it only certain sectors that would naturally do that?
Shrey: [14:00] Yeah, I mean, I think you've hit the nail on the head over here. And it goes back to sort of my analogy around the ice cream shop, right. So there will be certain sectors where the projects that you are funding naturally align to green eligible categories within the green bond principles or social categories, right. So if you are a sovereign or if you're a bank, there will be large parts of your balance sheet which are eligible for funding through a green bond or a social bond. Which is why when you see the market, a large component of the sustainable bond market as of now is corporates, banks, sovereigns, it's multilateral development banks and corporates from certain sectors. Now there are other sectors which are, quote on quote, more intensive sectors where a green bond may not form an active part of your funding mix. But the data that you're explaining to investors is pretty similar. And you could choose one of the cousins of a green bond, for example, a sustainability linked bond, to explain to investors what percentage of your energy mix will become renewable in the future, or what percentage of your car manufacturing becomes electric in the future, or what percentage of your natural forestry are you retaining from a biodiversity perspective? So I think the market has evolved to offer options for different issuers out there, and then get issuers to explain if they're not active in any one of them, then why not? And I think that's what investors are doing nowadays.
Jane: [15:28] And talking about investors, which is the other side of the transaction. And we alluded to it a little bit earlier, but why would an investor be actively looking at investing in these types of instruments?
Shrey: [15:40] Yeah. I mean, it goes back to, you know, what is a company strategy in the first place. So as an investor, what you're looking for is resilience of your risk and your return. And companies which think of issuing a green bond are usually better managed in terms of their business planning in the future. So a very interesting example is the auto manufacturing business or the auto parts manufacturing business. Now the reality is with China as a very large market where the auto industry is substantially electrified, electrified Europe as well is getting there. The auto parts industry has moved to serving conventional vehicles to electrified vehicles. If you weren't ready for this 10 or 15 years ago, you should be ready for this now. And if you're not ready for it in 15 years, then you know investors will get their return based on who's prepared for it. Now, from an investor perspective, you're getting the same credit risk profile with a bonus feature of having impact and better business planning. So again, it goes back to why not? As an investor, you want you want green bonds within your funding mix because it gives you a free option on better impact in the future. And look, investors globally have answered with a resounding yes to this as an instrument class. It's why 5 trillion of these are outstanding in the market today from not being in existence in formality you know, just over ten years ago.
Jane: [17:06] That's quite incredible, isn't it, the growth that we've seen? Now earlier this year, the London Stock Exchange supported capital raising for the World Bank and some other multi development banks via the hard-to-pronounce Climate Investment Fund capital market mechanism. That's snappy, Shrey. Tell me about that because that sounds really interesting.
Shrey: [17:27] So the Climate Investment Fund is a trust fund that's housed sort of within the governance of the world Bank. And the world Bank acts as a treasury manager. And it's a really interesting trust fund where effectively through donor countries, the UK being one of them, it funds climate investment projects in developing economies. So largely within the emerging world, anywhere from sort of Morocco, North Africa, Middle East, Asia, Asia Pacific. And whilst historically a lot of its funding has come from donor countries, it was looking for the first time to make investors part of its story. And it's very interesting because what it does is it brings together projects which are originated by the multilateral development banks, the likes of the AFDB, the European Bank for Reconstruction and Development, the world Bank itself and others, and presents that to investors and say, hey, would you like to be part of that story? So it was the first time that it was accessing capital markets very much to leverage the impact that it has. And it wasn't simple structuring either, in terms of what it takes to bring such an instrument to the market. Maybe that's why its name is quite complicated. It's actually two bits of it. It's a climate investment fund, and then it has a capital markets mechanism to access the market. And it did access the market and was incredibly successful in doing so, bringing together the sort of billions to trillions that you need to transform funding for climate investment.
Shrey: [17:27] So the Climate Investment Funds is a trust fund which sits within the World Bank or is governance is sort of within the World Bank, where the World Bank acts as a treasury manager. And what the trust fund does is it pulls together projects that are originated by a number of multilateral development banks to offer an opportunity for the funding of projects, which are key in terms of climate tech and climate investment. So it's a very interesting story over here, where it's a trust fund which is pulling together projects or is developing a pipeline of projects in partnership with multilateral development banks, which really answers the question, how do you scale private capital in terms of funding, where investment is needed the most?
Jane: [18:54] And is this a good example of blended finance where we're seeing the coming together of kind of public and private investment?
Shrey: [19:02] So blended finance can mean many things to many people. Yes. It is a story which started off as donor based financing from countries, and it has moved to the private markets. So these are exactly the types of stories, especially in terms of development or development impact in lower-income countries, that the capital markets are sort of keen to get through the door to investors. And quite frankly, it's what investors want to see, because additionality now exists in projects like these.
Jane: [19:29] Great. A really interesting development. Let's look forward. So let's think about the crystal ball that you have and your expectations of this market. Looking ahead, perhaps you can share your thoughts about that.
Shrey: [19:43] So funnily enough, I actually gave a phone call to some of the people who were there at the start of the market 10 or 20 years ago, and rather than answer this question myself, I said, Look, you tell me and I'll tell Jane. And interestingly enough, you know, whether you speak to actors like the multilateral development banks or companies, particularly the energy companies or investors, they all say something which is pretty similar. One, they didn't expect the market to be of this scale at this time. So the story of the sustainable bond market is incredibly positive[na3] . You know, I recall strategy presentations that we put together, and we certainly weren't thinking it would be the scale of what it is right now for the London Stock Exchange. And that's fantastic to see. I think the second thing that they say is that there is more to come from sovereigns, from emerging markets, from transition industries, because an existential question to answer for investors over the next 20 to 50 years is how you're adapting to a changing world. How are we moving towards a more liveable planet? How are we prioritising economic development, keeping in mind other challenges that we can see? And the core purpose of the instruments that I talked about, which is tell investors where your money is going to or tell them what impact you're going to have. It doesn't change. So effectively, there's an expectation that this market remains resilient or growing in the longer term. And I think there's optimism about innovation as well. There are parts of the industry where the market is just reaching to. So for example, supporting nature based financing or biodiversity, supporting investment in transition based industries supporting transition from fossil fuels for certain companies to, you know, more renewable energy mixes in terms of energy security, making sure domestic energy infrastructure is ready for renewables within the grid, battery storage, and a move towards considering nuclear within green taxonomies as well. So, look, I mean, this market will play an existential role in our future. And we're quite proud, privileged, I guess, to be one of the key components of it.
Jane: [21:53] I think that's a great place to call a close to our conversation. And I think I have learned a lot. I knew I would learn loads from you. Shrey, you are a mine of information and an inspiration. So thank you so much for coming and sharing your experience and your deep knowledge of this part of the market. Thank you so much indeed, and we look forward to another ten years of the London sustainable bond market.
Shrey: [22:18] Gosh, I will look older then but thank you.
Jane: [22:18] Thanks, well that's it for this episode of the LSEG Sustainable Growth podcast. I hope you enjoyed hearing from Sri about the sustainable bond market. If you've got questions, comments or someone you'd like us to talk to, then do get in touch by email lseg@fmt.com. That's all from me, but watch out for the next episode very soon.
