The Green Deal - 03/24 (EN) #responsiblebanking

• Primary market continues to be dominated by green bonds - but overall lost significant momentum compared to the start of the year
• We are currently seeing clearly positive primary market momentum for green bonds from the corporate bond segment
• ESG asset classes performed in line with the overall market in February
• ESG Investing with increasing headwinds in the US
• Green vs SLB: a clear winner
• Important metals for the green transition

The EUR ESG primary market remained solid in February and at the beginning of March. However, the market lost some of its momentum compared to the start of the year. While January 2024 was synonymous with the strongest start to the year (new issue volume) in the history of the EUR ESG bond market, the level could not quite be maintained in February. With a new issue volume of EUR 33.5 bn, this was slightly weaker than in February of the previous year (EUR 37 bn). It is striking that the start of the ESG issuance year in Europe is also currently at a record level in terms of green bond volume - however, the development in February was significantly below average compared to the global trend. Contrary to the global trend, the ESG market was somewhat more heterogeneous (not only Green Bonds) in February for the first time since September last year. Green bonds also dominated the month of February with a 52% share of new issues, but this dominance was significantly lower than in previous months. Social bonds in particular made a brief comeback in terms of volume in the previous month (EUR 7.7 bn), corresponding to a EUR ESG primary market share of 23% in February. However, a second look puts this comeback into proper perspective, as more than half of the social bond issue volume was attributable to one issuer (CADES). It is therefore not possible to speak of a broad-based trend here. Looking at 2024 as a whole, the proportion of green bond issues is at the level of 2023 (2/3). We expect this share to increase to 70% or more by the end of the year. Investors clearly seem to prefer green bonds over other ESG bond classes and issuers are increasingly adapting to demand - which is currently posing difficulties for the sustainability-linked segment in particular.

From a country comparison, it is striking that French issuers have significantly expanded their number 1 position on the EUR ESG market so far in 2024 and currently account for 25% of the EUR new issue volume, while the "number 2" on the ESG primary market, Germany, has lost significant ground as currently only 12% of EUR ESG primary market activity in the current year is attributable to German issuers. At the same time, the Supra segment has at least partially regained strength following the surprisingly weak issuance year 2023 and is at the same level as German issuers. At around 2.5%, Austria is currently well below the level of 2023 (5%) but at the same level as 2021. However, now that the Republic of Austria is also active as a green bond issuer, we consider 2023 as an appropriate benchmark for the year as a whole.

We are seeing a slight trend reversal with regard to the type of issuer. So far, the SSA segment has become significantly more important again compared to the previous year (share 2024 ytd: 47% vs 2023: 41%). In contrast, financial issuers have lost some ground and, with a market share of 20% in 2024, are well behind the corporate bond segment, which is currently well above previous years at 33%. We are currently seeing clearly positive issuance momentum in the corporate bond segment, meaning that this area could gain a significant presence in 2024.

Despite slightly higher asset swap spreads, the secondary market in February was characterized by unchanged low levels for risk premiums and rising government bond yields, particularly at the short end (2y/5y). All ESG asset classes recorded slight increases, with sustainability bonds standing out as moderate underperformers. Green & SLBs moved in line with the overall IG benchmark. Against this backdrop, the ytd total return for all ESG asset classes also remained in negative territory. SLBs continue to trade at elevated spread levels, which was also reflected in the primary market deals in February and early March (see Deals of the Month). Furthermore, the (non-existent) greenium for IG BBB Corporates is no longer exclusively attributable to the increased real estate spread levels (Chart 6), as we highlighted in our last edition already.

In contrast, the greenium for German twin bonds remains in negative territory. A decline from -4bp to around -2bp was observable in February. It is interesting to note that volatility has decreased significantly compared to 2022, as Chart 7 shows, which can generally be attributed to the end of the interest rate hike cycle.

The second-largest "ESG debt instrument" after green bonds - the Sustainability Linked Loan (SLL) segment - is struggling with significantly declining volumes worldwide, including in Europe.

The slowdown, which was already significant in the previous year, continued even more pronounced in 2024. According to LSEG data, only EUR-denominated ESG SLLs with a volume of EUR 4.3 bn were placed in the first two months of the year. In the previous year, this figure was EUR 6.3 bn and in 2022 (record year for the SLL market) it was as high as EUR 19.3 bn. Investors as well as borrowers are deterred by the increasingly complex regulatory framework but also by the fear of falling under suspicion of greenwashing. This is particularly worrying in view of the outstanding global volume of these instruments of EUR 1,600 bn. It remains to be seen to what extent the same trend will apply as in the bond market, where sustainability linked instruments are increasingly being replaced by green bonds. This is not yet clear from the market data on the loan market, but here too, green-loans could be much more appealing to investors. Although this instrument does not have the same history. At the moment, there are many indications that companies are currently returning to the traditional loan market (without any green label). Two other financial components are also likely to be decisive here. On the one hand, the financial advantage of "labeled" products (Greenium) has decreased significantly and at the same time the costs and effort for external ratings (second party opinion) have risen considerably. As a result, these products are no longer as attractive from a cost-benefit perspective as they were in the past. There seems to be an urgent need for new incentives to give the market new momentum and not just "new" regulatory burdens.

An increasing headwind for ESG investing is brewing in the USA. Recently, the negative news in this sense has been coming thick and fast. In February, high-ranking Wall Street investment banks and managers including JPMorgan, State Street and, to a certain extent, BlackRock announced that they had withdrawn from the Climate Action 100+ (CA100+) climate alliance. BlackRock has transferred its membership to its international subsidiary. As a result, around USD 14.000 bn in assets under management have been withdrawn from CA100+.

CA100+ is an investor-led initiative with the aim of encouraging the world's largest CO₂ emitters (currently around 170 companies) to reduce their footprint. As a primary measure to achieve the targets, the approximately 700 investors rely on activism, i.e. direct dialog with the management of the respective companies. AUM naturally plays an important role in such practices, as a larger relative ownership share can bring about more change. Against this background, it is clear that the loss of the above-mentioned investors, who account for around 20% of total AUM, is all the more significant.

US companies were increasingly confronted with political pressure from the Republican camp. They argued that such activism practices could lead to a breach of antitrust laws or fiduciary duty. However, none of the three cited this as an official reason. Instead, they referred to "in-house specialists" or emphasized the ability to act independently. Last June, for example, the CA100+ guidelines were amended to require investors to disclose their progress in negotiations with companies. Vanguard, one of the world's largest asset managers, was never part of the initiative.

At the beginning of March, JPMorgan, Citi, Bank of America and Wells Fargo also withdrew from the Equator Principles. This is an industry benchmark for assessing environmental and social risks in project financing. The reasons given were similar to those mentioned above.

BlackRock has now also removed the term "ESG" from its vocabulary, as this was increasingly criticized in the context of "Woke Capitalism". Instead of a general ESG focus, including the attempt to change corporate cultures and combat social problems, BlackRock is now focusing on "transition investing". This is intended to finance the transition from fossil fuels to renewables, as this is much more tangible. We agree with this. CO₂ reduction is currently one of the most measurable ways to combat climate change. The general shift away from ESG is probably also due to the upcoming US presidential election, in which Donald Trump's re-election does not seem unlikely. Donald Trump has repeatedly spoken out against ESG in the past. He also stated his position again in a recent campaign video. The eternal back and forth between Republicans and Democrats regarding the use of ESG investing in pension funds and the question of whether this violates the fiduciary duty has not yet come to an end either. Joe Biden had approved it, the subsequent lawsuit by the Republicans was dismissed for the time being, but is now being appealed.

As we have already pointed out several times in this edition of the Green Deal, we are currently seeing an increasing intensification of the trend on the market that green bonds are becoming the clear first choice for issuers and investors and that SLBs in particular are losing market share. This common issue is also reflected in our deals of the month.

• Snam, the Italian utility, has always been one of the pioneers in more "exotic" ESG bond classes. Snam is not only a regular SLB issuer, but was also one of the few issuers to use the transition bond segment. Up until now, the issuer has not issued any traditional green bonds. This changed in February when a dual tranche (SLB/green bond) issue was launched, which for the first time also included a green bond. The market response was relatively clear. The Green Bond (EUR 500 mn) issue was almost 6 times oversubscribed, while the large-volume (EUR 1 bn) SLB issue was 2 times oversubscribed. Based on the secondary market curve, the issuer presumably also enjoyed a price advantage in the green transaction. The Green Bond was priced with a negative new issue premium of 5bp, while at the same time a moderate new issue premium of 3bp was required for the SLB issue.

• The same held true for last week's deal by Dutch-based retailer Koninklijke Ahold Delhaize. The issuer placed a triple tranche of 2y, 7y and 12y with the middle maturity structured as a green bond and the longer maturity in SLB format. The green tranche was almost 6x oversubscribed with an order book (peak) of EUR 2.85 bn, while the SLB was only oversubscribed by just over 3x. Accordingly, the 7y tranche was also issued at a slightly negative NIP, while the SLB had a significant new issue premium of around 20 bp. Here too, we believe that the SLB KPIs are anything but ambitious. Absolute Scope 1 & 2 emissions are to be reduced by 50% by 2030 compared to 2018. A reduction of 35% was already achieved in 2023. In addition, the step-up is only 25bp. All in all, we can understand the different treatment of green vs SLB. The latter is also reflected in the IG ESG asset class indices, with SLBs trading at elevated spread levels (see secondary market).

Electric vehicles (EV) have experienced significant growth in recent years, resulting in strong demand for battery metals such as lithium, nickel and cobalt. Even though the EV market is currently facing headwinds due to high prices (vs ICE), insufficient charging infrastructure and the resulting consumer reluctance, the upward trend in EVs is expected to continue until 2030. This will also create demand for EV battery metals. However, not all EV battery metals are created equal, and thus neither are the underlying demand dynamics. Currently, EV batteries can be categorized into three major types. Nickel-manganese-cobalt (NMC), nickel-cobalt-aluminum (NCA) and lithium-iron-phosphate (LFP). NMC accounted for around 60% of all batteries in 2022, well ahead of NCA with just under 10% and LFP with around 30%.

While the proportion of cobalt is increasingly being replaced by a higher proportion of nickel (increases the energy density and therefore range of vehicles) or both nickel and cobalt are being replaced entirely (LFP), lithium remains the only constant. There is currently only one type of battery that does not require lithium (Li-ion), namely the Na-ion battery, but it is not expected to be widely adopted until the end of the decade.

The demand share of EVs for lithium is around 60%, for cobalt 40% and for nickel a relatively low 17%, even if this is expected to increase to up to 25% by 2030. Against this backdrop, we believe that lithium is best positioned of the three metals and forecast the highest demand growth rate. Despite declining cobalt content, we expect EV to more than compensate for volume growth. Nickel should also remain well supported, but EVs only play a subordinate role with a share of around 17% of total demand for nickel. This means that nickel is subject to the cyclical steel component.

In view of sharply rising production capacities, which should significantly exceed demand growth, we assume that price levels should remain at a moderate level in contrast to the extreme increases we saw in 2022. Here we also point to the EU's clear dependence on China, which dominates the EV battery value chain.

However, metals such as copper in particular, but also aluminium, are also important for the green transition and should benefit. The copper content in electric vehicles is about twice as high as in conventional ICEs and can even triple in BEVs, while the copper content in renewable energy technologies (wind and solar power) is about 2-6 times higher compared to conventional coal or gas-fired power plants. In addition, the charging infrastructure required for the successful introduction of EVs is very copper-intensive, weighing around 0.7 kg for a 3.3 kW charger and 8 kg for a 200 kW charger.

Aluminium is already an important metal for the green transition, partly due to its weight properties. The average aluminium content in cars is expected to increase from 205 kg in 2022 to 256 kg by 2030, as electric vehicles contain on average 60-80 kg more aluminum than combustion engines. However, the renewable energy sector, especially solar energy, will also boost demand for aluminium (1 MW of PV capacity requires 21 tons of aluminium).