The Green Deal - 11/22 (EN) #responsiblebanking

The ESG credit market was unable to escape the generally weaker market environment in October. Accordingly, primary market activity was significantly lower than in September, both in absolute and relative terms. However, we expect an improvement towards the end of the year, at least for the SSA- and Financials segments. The sentiment on the ESG secondary market also remained unchanged. With general risk-off and high volatility, the greenium remains in the background. In the meantime, the regulatory landscape in the EU has become more stringent for both banks (ECB threatens with stricter capital requirements) and corporates (keyword: CO2-free vehicles from 2035).

  • ESG primary market cannot escape overall weaker environment
  • Secondary markets under the spell of central banks
  • ECB increases regulatory pressures
  • EU agrees to the proposal to ban CO2 emitting vehicles
  • Canada plans transition bonds
  • Südzucker with inaugural SLB and TenneT underlines status as an ESG "big player"

Primary market

The EUR ESG primary market was unable to escape the general market trend of a lack of issuing activity. After primary market activity in September almost reached the level of 2021, it fell again in October - like the market as a whole - significantly behind 2021. In October, only EUR 18.9 bn of EUR-denominated ESG bonds were placed (Sep 2022 EUR 44.2 bn). The share of ESG issuance in the primary market also decreased again in October, amounting to only 11.8% of all new EUR issuance in terms of volume. This represents a decline compared to October 2021 (14%). However, the decline was even more pronounced compared to the previous month (Sep 2022), where ESG bonds still accounted for a quarter of all new EUR issues. Sovereign issuers and banks continue to dominate in terms of volume. Year-on-year, ESG issuance by sovereign issuers is down significantly, amounting to only 58% of the previous year volume at the end of October. The situation is much better at the bank level. They reached 85% of the previous year's level at the end of October and with new issuances still to come, we expect the financial segment to reach, if not exceed, the previous year's volume on annual basis. As the overall market, the ESG EUR corporate primary issuance is in a slack period. In our peer group, only issuers from three industrial groups (BICS1: Utilities, Consumer Discretionary and Consumer Staples) printed labeled bonds in October. In a year-on-year comparison, Industrials, Consumer Discretionary, Health Care and Energy are significantly behind the previous year's volumes and none of these industry groups has yet been able to achieve anything close to 50% of the previous year's volume. While we expect strong primary market activity in the financial and government segments for the remainder of the year, we expect only few issuances in the corporate segment throughout what is left of 2022.

Chart 1 - Monthly Issuance Volume - EUR ESG Market (EUR bn)
Source: Refinitiv, RBI/Raiffeisen Research

Secondary market

Secondary markets were strongly affected by the string of central bank meetings (ECB, Fed, BoE) in October and early November, with all regulators raising their policy rates by 75bp in line with market expectations. Nevertheless, with the inflation peak still not on the horizon (both euro area headline and core inflation for October came in above previous month levels and above expectations (Reuters poll)) and therefore still looming uncertainty about future interest rate paths (terminal rate levels and magnitude of hikes per meeting), volatility in sovereign yields was also high in October. The 10y Bund yield rose to 2.44% on 21 October from 1.9% at the start of the month only to retreat below 2% a few days later. Currently, we are at 2.35%. Similar behavior was seen for the 10y UST starting October at 3.65% with a later swing up to 4.23% and below 4% again. Symbolic for investors' uncertainty about the future direction was Jerome Powell's speech on Wednesday last week. In the policy statement a lower magnitude of rate hikes per meeting (including already the December meeting) was seen as dovish and resulted in a relief on the markets, but only to reverse substantially a few moments later when the Fed Chair said that the terminal rate levels currently priced in by the market may be too low. This led to a widespread risk-off that also swapped over to the European market. In general, gauges of credit risk in Europe rose slightly over the month of October. From an ESG perspective we have a similar picture as in September. Our BBB green index once again underperformed its non-green counterpart with spreads widening more significantly and the greenium still distorted by the real estate exposure as can be seen in Chart 2. Still interesting to observe is the erosion of greenium for the German twin bonds especially at the longer end of the curve. We are not sure what to make out of that, but it seems that investors are more willing to pay a premium for green bonds over non-green at times of lower overall yield levels. Especially the 2030 and 2031 papers have recently yielded higher compared to the conventional brown bonds. However, the overall movement might also be distorted from current volatile development and uncertainty that drives markets with less focus on the greenium.

Chart 2 - Corporate Green vs Non Green*
*EUR denom.; > EUR 250 mn; > 1y to maturity; Plain vanilla fixed coupon
Source: Refinitiv, RBI/Raiffeisen Research
Chart 3 - Financials Green vs Non Green*
*EUR denom.; > EUR 250 mn; > 1y to maturity; Plain vanilla fixed coupon
Source: Refinitiv, RBI/Raiffeisen Research
Chart 4 - Corporate green vs non green index spread development*
*BBB rating bucket; EUR denom.; > EUR 250 mn; > 1y to maturity; Plain vanilla fixed coupon
Source: Refinitiv, RBI/Raiffeisen Research
Chart 5 - Greenium German twin bonds
Source: Refinitiv, RBI/Raiffeisen Research

Hot Topic I: ECB tries green transition with "penalties" - China with incentives

The ECB communicated deadlines for banks as of which interim targets in the management of climate and environmental risks must be achieved. The announcement of this timetable follows the publication of the results of the "Thematic Review". In this review, 186 European banks were examined, where 85% of the sample was found lacking highly developed methods and detailed information to assess climate and environmental risks. According to the supervisor, 96% of the banks significantly underestimated the scope and scale of these risks betraying respective "blind spots" in the identification practices. Thus, the ECB announced three deadlines:

March 2023: A comprehensive assessment of the impact of climate and environmental risks on the banks' operations must be conducted.

By the end of 2023: Climate and environmental risks must be incorporated into the governance, strategy and risk management.

By the end of 2024: All ECB expectations (see the "Guide on Climate-related and Environmental Risk"), including the inclusion of climate and environmental risks in the stress testing framework, must be met.

The ECB plans to monitor these deadlines closely and threatens to increase capital requirements if the deadlines are not met. A few banks have already received higher capital requirements from the ECB (Pillar 2) due to lack of inclusion/analysis of climate risks. So here the ECB chooses a path to motivation via "penalties". In China, the regulator chooses a different path.

The Chinese Central Bank has created a possibility for banks to make loans that contribute to CO2 reduction more favorable. The borrowing costs for these loans are supposed to be close to the prime rate. If this is the case, the commercial banks receive 60% of the credit volume for 1 year from the central bank at 1.75%. Also, international banks are already planning to use this (e.g., Deutsche Bank and Societe Generale). Although China definitely does not often serve as a positive example in the ESG segment in this case we welcome this approach and hope that the ECB will consider similar steps. Thus, we would see positive not only a malus system (higher capital ratios) but also a bonus system. The latter could be designed in different ways - for example, lower RWAs for "greener" loans or more favorable refinancing costs for those (e.g., green TLTRO).

Hot Topic II: EU agrees to the proposal to ban CO2 emitting vehicles

The EU Council and Parliament reached a provisional agreement at the end of October to effectively ban CO2 emitting cars and light commercial vehicles (LCV; up to 3.5 t) from 2035 onwards. While the agreement is new, the proposal for such an amendment of the existing regulation has been already published in July 2021 as part of the EU Green Deal. The agreement still requires formal adoption by the Council and Parliament. By 2035 CO2 emissions from cars and LCVs have to be reduced by 100% compared to 2021 levels. In addition, the intermediate target by 2030 was tightened as well. Emissions have to be reduced by 55% for new cars and 50% for LCVs from previously 37.5% and 31%. The 2025 target remains unchanged at -15% vs 2021.

Even though this puts more pressure on OEMs to ramp up their electric vehicle fleet ambitions, manufacturer specific targets have already been in place for 2020 and 2021 albeit with different requirements. While the overall target, as stated in the regulation, is 95g CO2/km, the individual targets deviate as they are based on average fleet wide mass implying that heavier car fleets can emit more. In addition, there are some relaxations in place. In 2020 only 95% of the least emitting cars were included in the assessment as a phase-in period. For 2021, 100% of the fleet was considered for calculating the average CO2 emissions. Furthermore, for each registered car emitting less than 50g CO2/km a super credit can be applied for calculating fleet wide emissions. The super credit factor was set at 2x in 2020 and reduced to 1.67x in 2021. For 2022 the factor will be 1.33x before staying at 1x from 2023 onwards. Based on provisional data from the EEA, our analysis shows that OEMs managed to achieve their individual targets taking into account the super credits which are capped at a maximum of 7.5g CO2/km. However, the picture changes somewhat if those super credits are removed with only Mercedes Benz and BMW achieving their individual WLTP based 2021 target. Compliance with the targets was supported by the rapidly increasing share of alternative fuel vehicles (AFV) in the EU. In the first nine months of 2022 45% of all car registrations in the EU were AFV according to data from the ACEA (of which roughly 19% were battery electric vehicles (BEV) and plug-in hybrids (PHEV)). To put this in contrast: In 2019, AFV registrations accounted only for 11% before rising to 25% in 2020 and 40% in 2021. We would expect OEMs to achieve their individual targets also in 2022 on the back of the rising share of electric vehicles. For 2023, however, we could see a decline in the dynamic as subsidies for BEVs and PHEVs in Germany — the largest car market in the EU with a 27% share in 2021 — will be reduced and eliminated respectively. Nevertheless, the EU is still the global leader in terms of BEV and PHEV registrations even though China recently caught up in H1 2022 (roughly 20%) while the US is lagging (7%). But also in the US we do see progress. California just recently announced the ban of newly registered CO2 emitting cars, trucks and SUVs by 2035.

Chart 6 - EU passenger car CO2 emission targets
Source: EEA, EU, RBI/Raiffeisen Research
Chart 7 - OEM specific CO2 emission targets 2021
Source: EEA, RBI/Raiffeisen Research

Hot Topic III: Canada plans Transition Bonds

Canada, one of the world's largest oil and gas producers, announced that it is planning a framework to issue other ESG bond classes in addition to the existing Green Bonds. In particular, transition bonds are expected to play a more important role in financing projects that reduce the carbon footprint of carbon-intensive industries. Canada made its debut in the green bond market in March of this year with a CAD 5 bn issue just as the war in Ukraine started. The government agency Export Development Canada has already "put into operation" a framework that makes almost all types of ESG bonds possible - including transition bonds.

Chart 8 - CO2 per capita
Source: World Bank, RBI/Raiffeisen Research

Deals of the month

  • Südzucker issued its first SLB under the new sustainability linked financing framework. The EUR 400 mn bond was moderately well-received by investors with order books peaking at EUR 1.1 bn. However, the final pricing was still tightened to ms+220bp from IPTs of ms+237.5-250bp which is still quite a substantial NIP compared to the outstanding 2025 bond reflecting the current unfavorable environment for issuers. Südzucker paid roughly 12bp per term more for the new SLB compared to the 2025 paper. This might show why Südzucker was still able to tighten the pricing despite a rather weak order book. The resulting 5.125% coupon will be paid annually until 2027. There is no coupon step-up included in the terms of the SLB, however the principal amount will be adjusted upward by 0.5% at maturity if the defined KPI is not achieved among others. That is because the target observation date falls on 31 December 2026 and therefore will be included in the latest report before maturity of the bond. Südzucker set an absolute scope 1&2 emission reduction target of 32% by 2026 vs the base year 2018 (3.7 mn tons). Apart from the fact that it is an absolute target rather than relative (e.g. vs ton of products produced or revenues) and therefore also can be affected by the total operating activity in the specific year and does not necessarily indicate an efficiency improvement, the KPI is not very ambitious in our view. In FY 2021, Südzucker reported scope 1&2 emissions of 2.9 mn tons, already down 22% vs 2018. Over the last two FY, the company reduced their emissions by 11% (2020 vs 2019) and 6% (2021 vs 2020) each. To reach the 2026 target a CAGR of only -2.8% would be needed. Investors should therefore expect the 100% principal payment rather than the 100.5% in 2027. Finally, scope 3 emissions, of high importance for agriculture companies accounting for 3/4 of Südzucker's total emissions have been not included in the framework yet (even though the company has set a 30% reduction target by 2030). (Georg Zaccaria)

  • TenneT is back! The Dutch grid operator, which is the issuer of the largest European green corporate bond ever issued, has once again proven that they are experts in large-volume green bond issues even under difficult circumstances. The issuer placed four tranches with a total volume of EUR 3 bn in the maturity range between 6 and 20 years - and this despite the "long" maturities in the current environment - on the basis of a solid order book of EUR 6 bn (for all 4 tranches). However, the longest maturity cost the issuer quite a bit - the new issue premium (NIP) was 60bp. But also, for the two shorter maturities (6 and 9.5Y) the NIP was 25-30bp. The TenneT issue alone thus represented 1/3 of the EUR ESG corporate bond primary market volume in October. The issuance looks even more impressive when considering that the issuer has placed EUR 3.85 bn in May. With close to EUR 20 bn in ESG placements, TenneT is now definitely one of the "big players" in the green bond market. (Jörg Bayer)

Good to know

On 21 September, SBTi announced the first 1.5°C science-based framework to decarbonize the cement industry. The guideline is primarily aimed at clinker, cement and concrete producers, as well as manufacturers of novel binders and cement substitutes. In addition, it is also intended to support companies that purchase cement in setting targets for their scope 3 emissions. Overall, the cement industry, as the second largest emitting industry, is responsible for around 7% of global CO2 emissions. To get on track to achieve the net zero emissions target by 2050, this industry would need to reduce emissions by 3% annually by 2030. About 4.4 gigatonnes of cement are produced each year and currently emit an average of 0.6 tonnes of CO2 per tonne of cement. It is expected that cement demand will increase by around 20% by 2050. Currently, two thirds of the emissions come from the raw materials used (mainly limestone) in clinker production, while one third is due to fuel and electricity consumption. Currently, more than 30 companies from the cement industry have committed to the SBTi target or are on the way to doing so. Of these, one third are pursuing the net zero emissions target. (Link to SBTi)


Chart 9 - Yearly Issuance Volume - EUR ESG Market (EUR bn)
Source: Refinitiv, RBI/Raiffeisen Research
Chart 10 - Share of ESG bonds in the EUR primary market
Source: Refinitiv, RBI/Raiffeisen Research
Chart 11 - Country Overview - EUR ESG Market (EUR bn)
Source: Refinitiv, RBI/Raiffeisen Research
Chart 12 - Industry overview - EUR ESG primary market (EUR bn)
Source: Refinitiv, RBI/Raiffeisen Research
Chart 13 - Yields of German government bonds*
Source: *EUR denom.; > EUR 250 mn; Plain vanilla fixed coupon
Chart 14 - Yields of Austrian government bonds*
Source: *EUR denom.; > EUR 250 mn; Plain vanilla fixed coupon; Source: Refinitiv, RBI/Raiffeisen Research
Profile pic


location iconAustria   

Joerg leads the Fixed Income & ESG Research department. Before joining Raiffeisen Research, he gained expertise in international consulting projects, auditing and risk management, which gives him a broad perspective as he analyzed companies from different angles. In recent years Joerg has been working intensively on the topic of sustainability in the financial markets and developed the RBI ESG Scoring Tool for this purpose. If you have questions about all kinds of sustainable financial products, Joerg is the right person for you. Joerg is CFA Charterholder graduate in business administration and economics.

Profile pic


location iconAustria   

Georg Zaccaria leads the Institutional Industry Research. He also covers the metals & mining and automotive industry with focus on Europe. In addition to the Top-Down views, Georg covers single names on the fixed income side in both mentioned industries as well as selected AT issuers. Before joining RBI in 2018, he gained experience at Ernst & Young. Since August 2021, Georg Zaccaria is a CFA® charterholder.