Green gilts can help to build a low-carbon future

Gilts are turning green. Rishi Sunak, UK chancellor, said this week that the government will sell its first ever green bonds next year when the country hosts the delayed Cop26 climate conference. The move was part of a broader attempt to set out areas of potential growth for the country’s financial services sector after Brexit. The sale of green gilts will have a mostly symbolic effect on the nascent green finance market, but is still worth doing.

Green bonds must finance projects that contribute to reducing carbon emissions. They combine the usual promises made to bondholders — that they will receive their money back as well as interest — with a pledge to use the proceeds only for the agreed environmentally-friendly purpose. The idea is to encourage the allocation of capital to investments that will aid the transition to a less carbon-intensive economy, as well as satisfying the growing desire for savings products that meet investors’ moral standards.

To work they must create a “green spread”, so low-carbon projects pay a lower cost of capital than so-called brown ones. This needs to be sufficient to cover the additional costs of selling a green bond compared to a generic one: green bond issuers should provide more evidence of how funds will be used and report to investors on the progress. The head of the UK’s debt management office played down the possibility of selling green gilts earlier this year as it could cost taxpayers more than ordinary debt.

Money, however, is fungible. Cheaper funding for organisations that invest in many different projects, such as governments, or the banks that have been among the biggest sellers of green bonds, may end up freeing more funds for brown projects too. For a rich country, such as the UK, or many of the others that have sold green sovereign bonds — Poland was the first in 2016, followed by France in 2017 — borrowing costs are unlikely to constrain their ability to invest anyway. The UK currently pays a rate of 0.37 per cent to borrow for ten years.

That does not mean that green government bonds have no role. A green safe asset can provide a benchmark for pricing corporate and sub-sovereign debt and contribute to the development of a more sophisticated market for green finance. Selling green bonds, too, can provide a useful signal for investors and intermediaries.

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Ultimately, the best action any government can take to channel public and private funding towards green projects is using its ordinary powers to tax, spend and regulate. Universally-accepted standards and accounting frameworks are key to the development of green finance. But even these and similar initiatives can make only a small difference to the relative return from investing in different projects; a higher carbon price will have a much greater effect on lowering the relative return from polluting assets.

Mr Sunak should be under no illusion that any initiatives he discussed in his vision for a new City of London, including stablecoins or allowing dual-class share listings, will come close to replacing what the City is likely to lose from the government’s failure to prioritise a meaningful financial services deal as part of Brexit negotiations. That he was forced unilaterally to grant equivalence to EU financial institutions highlights the earlier failure to focus on a sector that is immeasurably more important to Britain’s economy than much-discussed fishing rights. His ambition to turn the City into a green finance hub is sound but, as with Brexit talks themselves, time is running short.

Letter in response to this article:

Here’s an alternative way to meet the net zero target / From Alistair Mackie, Ely, Cambridgeshire, UK

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