Net zero yes, but how?

Green bonds that finance environmentally-friendly projects remain popular with investors. However, the investors increasingly care not just about the projects, but also how the issuers plan to achieve net-zero greenhouse-gas emissions by 2050.

In Australia, the Queensland Government along with HSBC Australia were the first-ever private and public sector buyers of Reef Credits. The first water quality market of its kind in the world, Reef Credits will play a pivotal role in protecting the future of the Great Barrier Reef as both an Australian and international icon.

Also, 30 investors managing USD9 trillion of funds have now signed up to the Net Zero Asset Managers Initiative that aims for net-zero emissions across all managed funds by 2050 with interim targets for 2030. Oil & Gas bonds may be particularly vulnerable given their emissions.

The Bank of England is also being urged by a UK parliamentary committee to ensure its corporate-bond purchasing programme is aligned with the Paris Agreement's goal of limiting global warming to 2°C – better still, well below 1.5°C.

Bonds whose proceeds fund specific projects that reduce carbon emissions but which do not invest in fully green technology have been dubbed 'transition bonds'. There have been only limited issues, however.

Many transition projects could, in principle, be funded by green bonds, but some investors may be reluctant to buy such 'pale green' bonds.

However, investors may be given comfort by guidance in the new Climate Transition Finance Handbook published by the ICMA rule-setting body. Instead of defining transition bonds it requires a bond to finance the issuer's climate-transition strategy, which should be aligned with the Paris Agreement's goal.

The issuer's transition trajectory should also be relevant to its business model, have measurable and science-based targets, be publicly disclosed, include interim milestones, and be independently verified. And the issuer should provide transparency of the underlying investment programme, including capital and operational expenditure.

This framework can be overlaid onto existing green bonds – which fund specific projects – and sustainability-linked bonds, which do not fund specific projects but penalise issuers if they fail to meet pre-agreed environmental targets.

The aim of adding issuer-level disclosure is to give additional reassurance to investors, making it easier for 'hard to abate' sectors to finance decarbonisation without having to define yet another bond label. This is further evidence that sustainable-bond investors increasingly care about the issuers themselves.

Even if investors increasingly take the view that green bonds by themselves are not enough, green bonds still matter. We are forecasting issuance of USD310 billion to USD360 billion this year.

The European Commission this year published its strategy to promote a stronger international role for the euro, including developing EU financial markets into a global green-finance hub, promoting green bonds as tools to finance the energy investments needed to reach the EU's 2030 climate targets.

The EU wants 30 per cent of the bonds financing its recovery fund to be green bonds – potentially EUR225 billion, with issuance up to 2026.

France and Germany have already issued green bonds and plan to issue more, while Italy and Spain are expected to issue their first this year and the UK has sought an advisor on structuring a green gilt-edged stock. As for sustainability-linked bonds, we expect companies to increasingly find these an attractive source of funding.

First published 26 January 2021.

Author: Dominic Kini, European Credit and Green Bond Strategist

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Analyst Certification

The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Dominic Kini

Fixed income: Basis for financial analysis

This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other considerations.

HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its fixed income research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies in corporate credit and based on country-specific ideas or themes that may affect the performance of these bonds in the case of covered bonds, in both cases on a six-month time horizon; 2) to identify trade ideas on a time horizon of up to four months, relating to specific instruments, which are predominantly derived from relative value considerations or driven by events and which, in the case of credit research, may differ from our long-term opinion on an issuer. Buy or Sell refer to a trade call to buy or sell that given instrument; HSBC has assigned a fundamental recommendation structure, as described below, only for its longer-term investment opportunities.

HSBC believes an investor's decision to buy or sell a bond should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of terms as well as different systems to describe their recommendations. Investors should carefully read the definitions of the recommendations used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the recommendation. In any case, recommendations should not be used or relied on in isolation as investment advice.

HSBC Global Research is not and does not hold itself out to be a Credit Rating Agency as defined under the Hong Kong Securities and Futures Ordinance.

Definitions for fundamental credit and covered bond recommendations Overweight: For corporate credit, the issuer’s fundamental credit profile is expected to improve within the next six months. For covered bonds, the bonds issued in this country are expected to outperform those of the other countries in our coverage over the next six months.

Neutral: For corporate credit, the issuer’s fundamental credit profile is expected to remain stable for up to six months. For covered bonds, the bonds issued in this country are expected to perform in line with those of the other countries in our coverage over the next six months.

Underweight: For corporate credit, the issuer’s fundamental credit profile is expected to deteriorate within the next six months.

For covered bonds, the bonds issued in this country are expected to underperform those of other countries in our coverage over the next six months.

Definitions for trades (Rates & Credit)

Buy and Sell refer to a trade call to buy or sell a bond, option on an interest rate swap ("swaption"), interest rate cap or floor, inflation cap or floor, or Total Return Swap ("TRS"). The buyer/seller of a TRS receives/pays the total return of the underlying instrument or index at the end of the period and pays/receives the funding leg.

Buy protection and Sell protection refer to a credit default swap (CDS): the protection buyer/seller is effectively selling/buying the reference entity's credit risk.

Pay and receive refer to a trade call to pay or receive the fixed leg of an interest rate swap (IRS), a non-deliverable IRS, the firstnamed leg of a basis swap, the realised inflation leg of an inflation swap, or a forward rate agreement (FRA). An investor that executes a pay or receive trade is said to be "paid" or "received".

Payer and receiver refer to inflation caps or floors and to swaptions: a payer is an option giving the right but not the obligation to enter a paid position in an interest rate or inflation swap, and a receiver is an option giving the right but not the obligation to enter a received position in an interest rate or inflation swap.

ASW (also asset-swap, Buy on asset swap, Buy on an asset-swapped basis): Buy a bond packaged with a swap that is tailored to eliminate the bond’s interest rate risk, effectively transforming the bond to a floating rate instrument whilst preserving the credit exposure to the bond issuer.

RASW (also reverse asset-swap, Sell on asset swap, Sell on an asset swapped basis): Sell a bond packaged with a swap that is tailored to eliminate the bond’s interest rate risk, effectively transforming the bond to a floating rate instrument whilst preserving the credit exposure to the bond issuer.

Distribution of fundamental credit and covered bond recommendations

As of 24 January 2021, the distribution of all independent fundamental credit recommendations published by HSBC is as follows:

All Covered issuers Issuers to whom HSBC has provided Investment Banking in the past 12 months

Count Percentage Count Percentage
Overweight 125 27 78 62
Neutral 220 47 107 49
Underweight 126 26 51 40
Source: HSBC

For the purposes of the distribution above the following mapping structure is used: Overweight = Buy, Neutral = Hold and Underweight = Sell. For rating definitions under both models, please see "Definitions for fundamental credit and covered bond recommendations" above.

Distribution of trades

As of 30 September 2020, the distribution of all trades published by HSBC is as follows:

All Covered instruments Issuers to whom HSBC has provided Investment Banking in the past 12 months

Recommendation Count Percentage Count Percentage
Buy 157 69 95 61
Sell 69 31 29 42
Source: HSBC

For the purposes of the distribution above the following mapping structure is used: Buy/Sell protection/Receive/Buy Receiver/Sell Payer = Buy; and Sell/Buy protection/Pay/Buy Payer/Sell Receiver = Sell. ASW is counted as a buy of the bond and a paid swap, and RASW as a sell of the bond and a received swap. For rating definitions under both models, please see "Definitions for trades (Rates and Credit)" above.

For the distribution of non-independent ratings published by HSBC, please see the disclosure page available at http://www.hsbcnet.com/gbm/financial-regulation/investment-recommendations-disclosures.

Recommendation changes for long-term investment opportunities

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