Articles - The Green Green Gilts of Home


Green gilts are a sensible solution to a very real problem. The government can do far more than individual firms to combat climate change, and can take on huge projects that would be too large or tangential for any private investor. For example, one of the projects mentioned in the government’s green financing programme pre-issuance report is a proposal to replace 4,000 fossil fuel-powered busses with electric alternatives (along with the work needed to adapt depots, maintenance and so on).

 By Alex White, Head of ALM Research at Redington

 Green gilts allow the government to tap into the market for funding while fueling the growth of green industries in a virtuous circle.

 The report estimates that the project to electrify busses would replace c.180,000 tonnes of C02 for a cost of around one billion pounds.

 For context, the MSCI World has aggregate scope 1 and 2 emissions of around 60 tonnes per million pounds, so 180 tonnes per million pounds is meaningful.

 Green gilts look like a perfect investment for environmentally-conscious defined benefit pension schemes. These schemes often have significant gilt holdings as part of their LDI portfolios, and many have explicit climate beliefs and policies but aren’t in a position to invest in more traditional green assets – particularly those nearing their end game. Schemes approaching buyout are unlikely to benefit from investing in illiquid assets such as renewable infrastructure because, in general, insurers prefer to receive cash or liquid assets.

 Material sustainable equity investments probably won’t make sense either, because, by that stage, the scheme will have already de-risked. Green gilts offer essentially the same risks as nominal bonds, and while they have tended to trade at a ‘greenium’ of up to 4bps, this is generally very easily swallowed by a well-funded pension scheme.

 There is, however, one snag – and it’s a legal one. To caveat my view, I’m not a lawyer, and this is my second-hand understanding of the issue. Essentially, by law, every position a scheme holds must be justifiable on purely investment grounds. Since green gilts are directly comparable to brown gilts, it’s difficult to justify holding them on the basis of their climate impact. Therefore, although schemes could hold green gilts tactically – if they believed the price would rise relative to brown gilts – they couldn’t hold a large strategic allocation for climate impact reasons if it ceased to be financially advantageous relative to brown gilts, even if the overall effect on the scheme was negligible.

 What’s worse for members: the world being on fire when they retire, or earning 1bp less on some of their gilts? The issue is that each scheme on its own makes a negligible difference to global emissions. Therefore a scheme’s climate action has a negligible direct benefit to its members.

 The strongest counter-argument is that collective action could make a difference – and one that’s worth earning 1bp less on some gilts for. But until either a brave lawyer makes a similar interpretation publicly, a brazen scheme makes a large allocation on this basis, or parliament issues some clarifying regulation making this explicit, schemes may ultimately struggle to implement strategic gilt holdings.

 To me, this is an unfortunate technicality with potentially far-reaching consequences. Hopefully, someone in a position to address it will take up the mantle. My fingers are crossed, but the challenge is open.
  

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