The UK’s Debt Management Office (DMO) announced that it will issue its first Green Gilt on 21 September 2021 and intends to issue further Green Gilts with the aim of building out a green yield curve.
What are Green Gilts?
The launch of the Green Gilts is part of the UK Government’s Green Financing Framework and is designed to:
- mainstream green financial products,
- attract dedicated funding to meet the net zero target and other environmental objectives,
- finance sustainable projects,
- develop infrastructure, and
- create green jobs across the country.
The concept of a green bond is not new; the first green bond was issued by the European Investment Bank in 2007 and the market has grown rapidly in recent years to an estimated $1tn.
Differences to conventional gilts
- Proceeds from Green Gilts will be used specifically for green/environmental projects rather than general spending. The Green Gilts will finance clean transportation, renewable energy, energy efficiency, living and natural resources (Sustainable Farming), climate change adaptation, pollution prevention and control.
- Additional documentation is required to provide transparency to investors, in the form of a Green Financing Framework, a Second Party Opinion, and regular Allocation and Impact Reports on the projects funded.
- The Government has committed to initially issuing at least £15bn of Green Gilts, but that is a small fraction of the £2tn of conventional gilts outstanding, resulting in a difference in liquidity.
Increased disclosure and reporting is an important feature for any ESG investment. HM Treasury will publish a report on the allocations of the proceeds from the Green Gilts and on the environmental impacts and social co-benefits of them.
How will pension schemes use Green Gilts?
Like normal gilts, Green Gilts will mostly be used to hedge the interest rate and inflation risk of pension schemes liabilities via liability driven investment (LDI).
There are a number of challenges with this approach:
- Due to the high demand for green bonds, they often have a “greenium”, whereby investors receive a slightly lower yield than conventional bonds. As Green Gilts will likely offer a lower yield than conventional gilts due to the strong demand, it is likely schemes will not invest a lot in them.
- The current pipeline of Green Gilts is expected to have a shorter maturity than that needed to match the long-term liabilities of UK pension scheme, which will reduce demand.
There are challenges facing UK pension schemes using Green Gilts, but they will provide additional benefits such as:
- more engagement between investors and sovereign issuers, and
- greater disclosure, promoting increased sustainability objectives.