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Investing in the Low-Carbon Economy

The Paris Agreement on climate change and the U.N.’s 17 Sustainable Development Goals, along with corporate and investor initiatives such as RE100, the U.N. Principles for Responsible Investment and the Portfolio Decarbonization Coalition (PDC), have galvanized governments and business alike.

Private capital has never been given such an important role in tackling climate change and decarbonizing the economy. As Philippe Le Houérou, CEO of International Finance Corporation (IFC), says, the private sector “holds the key,” noting that it “has the innovation, the financing and the tools.”

He adds that unlocking more private-sector investment requires government reforms as well as innovative business models, which together will create new markets and attract the necessary funding. The potential exists to unleash trillions of euros of investment in renewable energy, smart grids, green buildings, sustainable transport and other green sectors.

Financing Decarbonization

Until recently, options for financing the energy transition have been limited. Amundi, Europe’s largest asset manager[1] , is attempting to address this constraint by creating innovative solutions to bring new large-scale funding dedicated to financing the low-carbon economy.

“We started looking at our carbon strategy on the equity side, trying to optimize our portfolios’ performance in relation to the benchmark while reducing carbon risk,” says Alban De Faÿ, Credit Portfolio Manager and Head of SRI Fixed Income processes at Amundi. “It’s one way to integrate climate- change risks into equity investments.”

Four years ago, Amundi partnered with Swedish pension fund AP4, index provider MSCI and France’s Fonds de Réserve pour les Retraites (FRR), to develop a range of low-carbon indexes and subsequent passive investing strategies for a new market of investors seeking to manage and mitigate their carbon risk exposure. The MSCI Global Low Carbon Leaders Indexes consist of companies with significantly lower carbon exposure than the broad market average.

Many emissions-intensive sectors already provide good-quality data, but other sectors are in their infancy. Amundi is actively pushing all major companies to provide more information, and to learn how to assess carbon exposure risks.

“Low-carbon indexes are a good way to learn about these topics and help equity investors reduce their risk,” says De Faÿ. “We really need to improve the quality of the data and standardize this kind of risk, and building new indexes is a good way to improve the amount and quality of data available.”

Expanding the Green Bond Market

Amundi is also at the forefront of efforts to expand the green bond market, and launched its first open-ended green bond fund in 2015, and its first 100 percent green bond fund in 2016, which aims at  measuring the positive environmental impact of the funds it lends.

“In fixed income, it’s quite different from our approach in equities,” says De Faÿ. “Our main focus is how we can finance low-carbon projects and help issuers to accelerate their move towards low-carbon economy. We want to offer investors solutions to innovate and finance more green projects. The development of the green bond market will help us to launch several strategies with new opportunities for investors to be part of financing the low- carbon transition.”

The two green bond funds maintain different strategies to fit the requirements of investors looking to finance the low-carbon transition. The first fund aims at financing key players involved in the  energy transition.  Its strategy leverages green bonds as a financing mechanism with high transparency and enlarges this universe to other issuers which embrace the transition towards sustainable energy.

“ In addition to green bonds,  we also fund ‘pure play’ companies that have more than 50 percent of their turnover dedicated to low-carbon activities— like for instance a company which is a leader in energy efficiency and smart grid applications,” explains De Faÿ. “There is a big gap between the energy we produce and what is available to use because of transmission losses, so they can make a real difference”.

“In addition, there are a lot of sectors facing big challenges in relation to their carbon footprint, where they really need innovative investors to help issuers transform to low-carbon. It’s about both risks and opportunities,” says De Faÿ. “In automotive, for example, there’s a lot you can do to improve engines and make materials lighter to improve fuel efficiency, quite apart from the opportunities in electric vehicles. In chemicals, there are many ways to reduce pollution and emissions, and even banking has a key role to play in financing the energy shift to low carbon,” he says. The fund also finances issuers identified as leaders in those key sectors due to their proactive approach in terms of climate change mitigation.

Amundi’s second green bond fund uses an impact-investing strategy.  It only invests in green bonds where the issuer provides evidence on key environmental indicators, such as CO2 emissions avoided. This allows investors to finance sectors that might be deemed environmentally risky, as these sectors prove they are making improvements.

In equities, investors want to reduce their exposure to carbon risks, and may seek to avoid high-emissions sectors such as utilities. However, for fixed income investors wanting to invest sustainably, such companies may be attractive as  green bonds are an efficient tool to help electricity generators innovate and move away rapidly from high-carbon power plants.

“We want to direct finance to where it is most needed, even if the companies involved have a higher carbon footprint,” he adds. “Funding renewable energy projects is a way for investors to support the tremendous need of financing to stick to a 2 degree Celsius scenario trajectory.”

Challenges Remain

When the green bond market came into existence, there were concerns about how investors could be sure that their money funded low-carbon projects, but this has been eased by greater transparency. Today, investors can be more confident about the quality of the issuance and the ability of the issuer to make an impact.

The next challenge is to create a single, standardized definition of what is and isn’t “green.” For example, in China, clean-coal projects can be considered as green, but in Europe, they won’t. De Faÿ believes that the EU’s Sustainable Finance Action Plan, which includes a sustainability taxonomy, will be “a big help.”

Similarly, levels of transparency still vary from issuer to issuer. In the utilities sector, the information tends to be comprehensive because it is the sector’s own assets that generate data; in banking, metrics can be more opaque because the sector is reliant on more third-party information.

More diversity is needed in the types of issuers and the yields they offer. The green bond market has, to date, been chiefly made up of issuance from the multilateral development banks, which offer great security to investors, but low yields.

“Many investors are looking for a higher yield, and green bonds can’t offer that yet,” acknowledges De Faÿ. “The market needs more corporate issuers providing higher yields to meet the needs of all type of investors. If we can develop a high-yield market, it will drive more low-carbon investment.”

The Climate Bonds Initiative

The Climate Bonds Initiative states that banks need to issue more green bonds and green loans, and increase their underwriting support for the sector. This would also help the market to finance more than just large-scale renewable energy facilities and portfolios of green loans for banks. Amundi has the capabilities to cooperate with banks on these issues, to extend the green market to all fixed income market segments due to the expertise of dedicated teams speciazlised in these specific segment like loans, smaller bonds and private placements.

“It would be nice to imagine that one day we will have green market on all types of solutions, such as asset-backed securities [ABS] and collateralized loan obligations [CLOs],” says De Faÿ. “If we do this, we will have a market that answers all the different types of financing needs for companies and the needs of investors around risk and return. It is starting to happen, but at the moment, we are not able to deploy all of these fixed income weapons.”

In the spring  of 2018, Amundi launched a green strategy in partnership with the World Bank to support demand for green bonds (through a €1.5 billion fund investing in emerging-market green bonds) and green bond supply (through the World Bank’s sister organization IFC, which seeks to support green bond issuance in emerging markets). This strategy is the world’s largest emerging market-focused green bond fund, and aims to increase the capacity of emerging-market banks to fund climate-smart investments.

The long time frame and large size of the fund is expected to significantly increase the scale and pace of climate finance in emerging markets by drawing in capital from both local and international investors, and by creating new markets. It is expected to deploy $2 billion into emerging-market green bonds over its lifetime, as its proceeds will fully invested over seven years in green bonds.

The market for sustainable finance products remains small. Interest from investors is strong and growing, and as more products become available that meet the requirements of a wide range of investors, sustainable finance is set to go from strength to strength, bringing new momentum to the low-carbon transition.

To find out more about Amundi Asset Management click here.
Written by Mike Scott, for Bloomberg Media Studios

[1] IPE “Top 400 asset managers” published in June 2018 and based on AUM as of end December 2017.

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