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Shades of Green

10 September 2014
Richard Kemmish

Munich Hyp have just announced the launch of the first ever green pfandbrief (actually an ESG bond, green nomenclature is a complex area).  I’ve always been a big fan of Munich Hyp, although I can’t say if it is because of the professionalism of their treasury or their chutzpah in describing themselves as the Royal Bank of Bavaria (given what the Bavarians did to their last king).

Reactions to green bonds tend to bifurcate on the basis of existing prejudices. So it would be easy to be simplistic about it. Which would of course be a mistake. Rather than alienate 50% of readers by imposing a personal political opinion, I’d rather ask a question: is it really green? Up to you what you do with the answer.

Use of proceeds is very important in the green bond market. And it’s always something that I personally have struggled with – surely money is fungible? You put money into your bank account; you take money out of your bank account. You can’t say which pay cheque you used to buy your new sofa.

So the concept of segregation of proceeds was invented for green bonds. If I raise money via a green bond, it stays in a separate account until disbursed for a green investment. It is inefficient from a treasury point of view but makes it clear that the investor money really is going to fund specific projects.

But there are flaws with that argument, both general and specific to covered bonds.

What if the green assets default? The investor will still want their bond to be repaid with the full faith and credit of the institution – effectively the non-green assets. Only if the repayment of the bond was asset performance specific could the investor truly say that they were taking green risk. And for that they would demand a higher return.

To date green bonds tend to price in line with non-green bonds of the same issuer (KfW’s recent debut deal being a good example), and repay based on the credit of the entire issuer. Both of which undermine the concept. 

Securitisation, where bond repayment is already linked to the performance of the underlying asset seems a more natural funding source (not often that I say that).

The covered bond specific problems are two fold. Under German law cover pools can not be segregated. The Munich Hyp bonds will be backed by assets that meet set sustainability criteria, but they are in the same pot as all of the other assets backing all of the other pfandbrief.

In theory in other countries it would be easier, for example in the UK, you could set up two separate, differently coloured guarantor SPVs. But even then the previous problem still applies. If green SPV breaches its Asset Cover Test, issuer will be obliged to add more assets. It would be inconceivable that the green and non-green programmes could not cross-default. 

Also, under German covered bond law (and every other one too) the assets must already exist. So we can not say that the covered bond proceeds are funding new green assets. They are just refinancing existing ones.

But for me the real test is whether this bond increases the economic incentive for Munich Hyp to originate assets that meet the ethical criteria.

And that, investors, is up to you.


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