Transcript
Speaker: This is HSBC Global Viewpoint, your window into the thinking, trends and issues shaping global banking and markets.
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Speaker: A heads up to our listeners that this episode has been recorded remotely, therefore the sound quality may vary.
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Speaker: You're listening to the Markets and Security Services Outlook, a podcast miniseries exploring the critical topics that will shape our industry in the next decade, including sustainability, digitalisation and emerging markets.
Speaker: Find out what's driving the global outlook for institutional investors and where the opportunities and challenges lie.
Speaker: Thank you for joining us.
Speaker: We'd like to present a panel discussion and what we're going to focus on is practical steps that will help to enable net zero through investment choices.
Speaker: And in order to do that, we have three panelists who are joining us from within HSBC, from Markets and Security Services, from Global Banking and from HSBC Global Asset Management.
Speaker: So I'm just going to ask the three panelists to introduce themselves, please, starting with Patrick.
Speaker: Hi Chris and thanks for the introduction.
Speaker: So my name is Patrick Kandarshan.
Speaker: I sit in the market and security services division of HSBC and I'm in charge of products and commercialization in the Asia space.
Speaker: So we work with our clients to find the right solution that help them achieve both their risk and return objectives as well as the Asia objective combined.
Speaker: Thank you Patrick and Farnham.
Speaker: Morning everyone and thank you Chris and Zoe for the introduction.
Speaker: My name is Svarnam Bidgoli and I lead the ESG Solutions team for HSBC in Europe.
Speaker: So this is a cross capital markets team that's focused on sustainable finance, including the origination of green social and sustainability bonds.
Speaker: Thank you.
Speaker: And Michael?
Speaker: Good morning, Chris.
Speaker: So I'm Michael Ridley.
Speaker: I'm in asset management and I lead on investments where we do a lot of work on sustainable infrastructure, green bonds and natural capital.
Speaker: So the first question is to start off with Patrick.
Speaker: And the question is about what changes in investment will be necessary in order to achieve the transition to net zero.
Speaker: So, Patrick.
Speaker: Thank you, Chris.
Speaker: In terms of changes, I mean, the scale in the real economy is immense.
Speaker: And a good example is quoting the Bank of England, which recently said that in the UK alone, spending on low carbon technologies and infrastructure will need to rise fivefold from 10 billion to 50 billion a year or 2.5% of GDP.
Speaker: So we are the financial markets and what can we do and how can we help?
Speaker: And I think in finance, finance is an enabler and is very powerful in the sense that it can hold market participants accountable by actually allocating the capital, which is a great tool.
Speaker: So, you know, in the future, organizations that will not embrace CSG will find themselves potentially marginalized and with no access to funding or at a much more expensive cost.
Speaker: And I think from discussion we have with our clients, it's pretty clear that, you know, deep changes are needed.
Speaker: And, you know, the wheel is there from the bank, the asset managers, the asset owners, everyone in the ecosystem.
Speaker: And we moved from the why, which was
Speaker: a question a few years ago, right?
Speaker: Why should I do this?
Speaker: And am I compromising on my returns, et cetera, to the how.
Speaker: And that happened already some time ago.
Speaker: So that's a really good news.
Speaker: And the other good news is that investors have more products available to invest into more ERG-friendly options.
Speaker: We have better data as well.
Speaker: Also not perfect, but improving by the day.
Speaker: And we have also clearer regulatory frameworks that are being developed.
Speaker: And the fact that we have better data, it means that it's easier to measure and better allocate capital to best in class companies or people who are on the right track actually to decarbonize or to transition.
Speaker: Today, it's much easier for me to measure if someone generates a lot of emissions or someone is on the right track for their temperature alignment and so on and so forth.
Speaker: So in a way, a lot can be done already today with the existing set of products.
Speaker: Where the challenge actually lies is more on the scale and the capacity, especially in the impact space.
Speaker: So the more kind of SFDR9 article type of investments.
Speaker: And here there is a capacity constraint.
Speaker: And this capacity gets more problematic.
Speaker: the more money you manage, the bigger you are, the more you are constrained by this.
Speaker: I can give two examples.
Speaker: One is in the natural capital space, so biodiversity.
Speaker: So if you think about ocean, this is basically the planet's largest carbon sink.
Speaker: But still, how do you deploy capital at scale to invest in ocean preservation?
Speaker: Not an easy one.
Speaker: And if you look at the bond space, for example, there have been only a handful of blue bonds ever issued, and maybe Farnam can comment on that.
Speaker: Another example, which is not in the climate space, but not in the social space, if you look at SDGs three and four around education and healthcare,
Speaker: The size of the projects are relatively small in general, and there is a disconnect between investor size, risk profile, liquidity requirements, et cetera, and the projects available.
Speaker: So the challenge is still there in terms of scale, but this is something that will grow over time on the impact size as technology evolves, as governance spending comes through infrastructure, through things like the Green Deal, et cetera.
Speaker: But it doesn't mean that we should just do it and do nothing.
Speaker: There is a fair amount of products available and gradual approach can and needs to be taken.
Speaker: And you can see this in regulation as well, such as SFDR, where there are different shades.
Speaker: So again, the word here is transition.
Speaker: Things are available.
Speaker: There's a huge amount of changes needed.
Speaker: I think everyone is aware of it and we have more and more tools to do it.
Speaker: So that's the good news.
Speaker: Thanks very much, Patrick.
Speaker: And Farnham, Patrick was mentioning about blue bonds.
Speaker: We've heard a lot about green bonds and sustainability bonds.
Speaker: What are your thoughts about the changes in investment that are necessary?
Speaker: Absolutely.
Speaker: I think Patrick rightly makes the point that the challenges have been there in terms of the deployment of capital at scale.
Speaker: So when we think about use of proceeds bonds, be they green bonds that are dedicated towards environmental projects or blue bonds, which are essentially a subset of green bonds that focus on marine conservation and water issues.
Speaker: we were always looking towards sort of identifying projects, identifying investments, and then ensuring that there was data available on reporting on the impacts of those projects specifically.
Speaker: And I think Patrick makes a good point that the deployment of capital within issuers, be they even public sector or private sector,
Speaker: towards those specific projects has been quite small.
Speaker: Effectively, you're often still looking at research and development projects and expenditures within companies rather than the sort of large-scale infrastructure, which is usually a public and private collaboration.
Speaker: I think the interesting development over the past several years has been moving away a little bit from this approach of identifying and ring-fencing projects towards more so looking at the issuer
Speaker: And within the debt space, what we've seen is the development of sustainability-linked bonds, where the issuer makes commitments with regards to either their emissions footprint or in the case of, to go on with the example of marine and water conservation, potentially with the resource footprint that they have.
Speaker: And then the instrument itself is linked towards the achievement of those outcomes.
Speaker: And if the issuer fails to meet those outcomes, there is some sort of mechanism for accountability, be it a higher cost of capital or reinvestment into new projects.
Speaker: And I think that structure is helpful in the sense that it allows for
Speaker: the kind of allocation of capital towards issuers that are making credible commitments, that are accountable to those commitments, while taking away a little bit of that burden of identifying specific projects and reporting on those specific projects.
Speaker: Thanks very much, Farnam.
Speaker: That's very interesting, that sort of shift towards sustainability-linked bonds, as you say, and
Speaker: the outcomes from issuers and the whole subject of the measurement of how issuers perform against those outcomes.
Speaker: And obviously that's very relevant to where I sit in security services as to finding ways of measuring ESG and sustainability outcomes.
Speaker: So that's very interesting how that shift is likely to become more in that direction.
Speaker: So Michael, last but not least, your views on the changes of investments that will be necessary.
Speaker: Thank you, Chris.
Speaker: So in asset management, we're working on two I can mention.
Speaker: So sustainable infrastructure, natural capital, inspired by what we saw in the green bond market with the green bond principles.
Speaker: Fast Infra, which is a public private partnership, is trying to get a label for sustainable infrastructure to help accelerate the flow of private finance to infrastructure that's sustainable in the developing world.
Speaker: And that's a public private partnership.
Speaker: We have a label which is under consultation.
Speaker: And we think that will do great work in terms of getting host governments and developers to focus on environmental resiliency standards at pre-construction phase, which is the time to do it when it's most able and cheapest to make your asset sustainable.
Speaker: And then it will invite in institutional money that wants to create sustainable infrastructure debt funds.
Speaker: It'll give them the arm's length sort of authority to say, here is a label that's being provided.
Speaker: Externally validated.
Speaker: So as the Green Bond market was accelerated by the Green Bond principles, hopefully a loan market that tends to fund sustainable infrastructure can be come up, come up, awakened in that way.
Speaker: And Zoe also mentioned in that in the work we're doing on natural capital in asset management, we tend to think that sort of three or four things are happening all at the same time.
Speaker: to accelerate this market.
Speaker: We're getting the creation of metrics to measure biodiversity, so mean species abundance is a key metric.
Speaker: We're getting asset owners stacking cash flows from the assets they own, so not just sustainable agricultural products but carbon permits, tourism, etc, etc.
Speaker: So more than one flow of cash from the asset.
Speaker: There's a recognition of the double benefit of natural capital.
Speaker: You slow climate change and you
Speaker: preserved biodiversity and also the commitments towards net zero that countries and companies are making makes a natural market for nature-based solutions.
Speaker: So we would say, yeah, more innovation, broader array of products and two that we're looking at are sustainable infrastructure and natural capital.
Speaker: Thank you, Michael.
Speaker: It certainly sounds really exciting, the innovations you're just describing there.
Speaker: And Farnham,
Speaker: Yeah, I mean, I think innovation is a word that maybe provokes a lot of thoughts around sort of big changes that are due to happen.
Speaker: I actually think, I mean, some of it is going to be incremental.
Speaker: I mean, when I talk about the big innovation in the debt space over the past several years of sustainability linked bonds, I mean, we've always had bonds that have covenants.
Speaker: This is just the first time those covenants have been
Speaker: tied to sustainability.
Speaker: I also think, you know, some of it will be kind of hybrid structures.
Speaker: So Michael made the note around, you know, the need to kind of bring in natural capital accounting into general finance structures.
Speaker: I mean, that's really tying two things together.
Speaker: So for instance, in the sovereign debt space, you know, could we have the sovereign making some of its repayment commitments in the form of
Speaker: investments in natural capital and the investor taking returns in the sense of carbon offsets, for instance.
Speaker: And I think some of it will also be anti-innovative.
Speaker: There's a lot of conversation right now about what should be happening in the equity space.
Speaker: And I know that there's been some dialogue around having green equity, for instance.
Speaker: And I personally think that's a step backwards.
Speaker: I think that we should be thinking about integrating
Speaker: climate metrics and ESG metrics fully within our existing equity markets, we shouldn't be ring-fencing and creating new products within equity markets to reflect this.
Speaker: Brilliant, thanks.
Speaker: And Patrick?
Speaker: I mean, a lot has been covered.
Speaker: I think definitely the natural capital side of things.
Speaker: This is a great area.
Speaker: And finding how we can connect investors with the projects directly and create the right level of transparency and due diligence and make it simple, actually, for investors to access to this.
Speaker: and to create structures that have the right liquidity, the right risk profile, and the right tradability.
Speaker: I think that's the kind of area where I think a lot will happen and will be very critical.
Speaker: And, you know, Franam mentioned the sustaining bond, and I think those mechanism of performance-linked
Speaker: instruments are happening not only in the bond space and now we are implementing this with all the public market instruments and that's very key because it really is at the company at the global level at the higher level of the company and that's very powerful kind of instrument and I think that will grow and those kind of covenants will become more and more standard into more and more products.
Speaker: The next question is how much of a headwind is caused by the gerenium and how can this be overcome?
Speaker: Farnham.
Speaker: I think the reality is that the greenium where it exists, I think, is simply a supply and demand imbalance.
Speaker: We've talked about all of the barriers and challenges that there are right now towards achieving the scale that we need.
Speaker: I would say another facet of this is the fact that right now, inflows into ESG-related funds, be the APMATIC funds, sustainable investment funds, or ESG integration funds,
Speaker: are far outpacing the availability of product.
Speaker: So we talk a lot about the acceleration of issuance, for instance, the debt market,
Speaker: of sustainable products.
Speaker: And indeed, we're on track this year for probably a trillion in green social sustainability and sustainability-linked issuance because we're just about half a trillion so far at the halfway point.
Speaker: But that still only reflects 10% of all outstanding bond issuance.
Speaker: And if you look at subsets of the market, if you look at the dollar market, for instance, then it's even smaller percentage of all.
Speaker: new issuance coming in in labeled format.
Speaker: So we have this supply and demand imbalance.
Speaker: What that means is that it is an issuer's market, so to speak, that we're seeing a greenium in most cases.
Speaker: Although I would even point to the fact that in sectors where green issuance is more commonplace, so for instance, in utilities,
Speaker: that greenium is much smaller and we're seeing it shrink.
Speaker: So really what we need is to, you know, address some of these barriers that we've been talking about so that the market grows.
Speaker: And then, you know, when we get to what I think has always been the intended outcome of this, which is that, you know, all finance is sustainable, that I don't think you'll see this kind of greenium, so to speak.
Speaker: There might be a penalty on the other side for issuers that are not following down this path.
Speaker: But we'll have eliminated the greenium.
Speaker: Thank you.
Speaker: Thank you, Farnham.
Speaker: And Michael, do you have thoughts on the greenium headwind?
Speaker: Yeah, of course.
Speaker: I mean, there's sort of two ways to talk about the greenium.
Speaker: In one respect, you talk about in the green bond market, green versus non-green, and, you know, that's a fascinating conversation.
Speaker: I mean, I tend to think a bit more broadly about a green premium across the board.
Speaker: You know, every product, every project in the world, you know, is it more expensive to do the green route or the non-green?
Speaker: Now, basically, when we've got to the stage where in every sector, the green alternative is cheaper than the non-green, we'll have achieved net zero.
Speaker: You know, so we're basically having to push down.
Speaker: the green price premium in every sector.
Speaker: Now, that happens.
Speaker: How does that happen?
Speaker: It happens with government support, R&D, technology, carbon prices.
Speaker: We kind of need to throw everything at that over the next 30 years to pull that down and to make the green alternative the natural choice and the cheaper.
Speaker: Now, as I say, we can do that with carbon pricing.
Speaker: You know, you add on a carbon price.
Speaker: And so in Europe over the last 15 years, it made it better to run gas-fired power plants than coal.
Speaker: in the future we want a carbon price that means we're running green hydrogen rather than grey hydrogen.
Speaker: So we're needing to use all of these governmental measures to flip the market towards the green alternative, but the private sector can help with R&D and research and just innovation.
Speaker: So I kind of think it's an issue writ large, but that's the task we have, is to pull
Speaker: the green premium down to a negative and therefore we just have green activities and we're at net zero.
Speaker: Just a follow-up question if I may Michael, just you mentioned 30 years.
Speaker: Now 30 years sounds like the sort of the end of this, the outcome.
Speaker: How do you see that playing out over the next 30 years?
Speaker: How much in the next say three years, five years, ten years?
Speaker: You know, net zero in theory is by 2050, but a lot of people have started talking much more detailed way about 2030.
Speaker: And instead of two degrees, it's one and a half degrees.
Speaker: So in some respects, and it's not just scope one and two emissions, it's scope three.
Speaker: So people have been sort of ratcheting up, actually, quite interesting over the last year, the ambition.
Speaker: And I think I've seen over the last year, you know, the focus on net zero means action starts now.
Speaker: It's costly to defer.
Speaker: I do tend to think that Build Back Better in the West is the sort of sweetener to transition to net zero.
Speaker: So there's a political push that we get people moving now.
Speaker: I would say all companies are very focused.
Speaker: And in some respects, it's a 2030 goal.
Speaker: I think the UK has a 2035 goal of 78% emission reduction, which is aggressive.
Speaker: And that includes the UK share of global aviation and shipping as well.
Speaker: So there's sort of different measures, but actually there's been a telescoping in to the nearer future, I think, over the last year, which I think is very healthy and means people get to work basically now.
Speaker: Brilliant.
Speaker: Thank you.
Speaker: And Patrick, your thoughts on the greenium?
Speaker: Yeah, I'll be quick on that.
Speaker: I mean, on the bond market, Farnam covered this, and I have the same view.
Speaker: If anything, the green is not holding back invest.
Speaker: It is a byproduct of the imbalance between between normalize over time.
Speaker: Also, you need to think about the costs.
Speaker: Obviously, issuing a green bond is more expensive.
Speaker: You have reporting behind, you have framework to maintain and so on, but this is minor.
Speaker: In other products, think EAG products, think equity indices, for example.
Speaker: Is EAG more expensive or less expensive?
Speaker: Again, it's all driven by market forces.
Speaker: What's the liquidity?
Speaker: What's the cost of hedging?
Speaker: And so on and so forth.
Speaker: But again, if you think ESG, it means you are filtering or screening to some extent.
Speaker: So there is a trade-off between liquidity, cost and ESG-ness if you want.
Speaker: So if you are very extreme and say, I'm going to screen and just keep the top 10% of companies from a carbon footprint or ESG score, whatever it is,
Speaker: Ultimately, it will be much less liquid and probably more expensive to hedge.
Speaker: So there is this balance to keep in mind and everything has a cost, but it's driven by market forces mainly today.
Speaker: Okay, so moving on to the final question, which is which types of regulatory intervention will be most effective?
Speaker: And I'm going to ask Michael to kick off with this one, please.
Speaker: Well, thank you.
Speaker: Well, I think I may have intimated already that we kind of need to use as many tools as we possibly can.
Speaker: But absolutely, you know, my background as an economics training, obviously the carbon price is a key, key measure.
Speaker: We're not going to get a global carbon price, but we are going to get more and more regional carbon prices.
Speaker: And the EU price is $50 plus.
Speaker: So I think that's very positive.
Speaker: Beyond that, it's regulation, it's R&D.
Speaker: absolutely finance and governments need to work together.
Speaker: I mean, in some respects, finance is kind of value neutral.
Speaker: We supply the services and we need people to be driven to come and want them.
Speaker: And in many respects, they'd be driven by, okay, it's partly, you know, having the right product for their consumers, but it's also a lot is regulatory driven.
Speaker: So absolutely, that's why COP26 in Glasgow is so crucial.
Speaker: And the more we have net zero commitments from countries, that is then translated into domestic legislation or international legislation.
Speaker: And it's all very powerful.
Speaker: So I'm very much waiting for this to happen.
Speaker: Absolutely.
Speaker: Each ratchet forwards is really important indeed.
Speaker: Thank you, Michael.
Speaker: I was going to actually pick up on something you mentioned before as well about the scope three emissions and the importance of those and how a year ago I sat through a five-hour EU open session on open hearing on the plans for the sustainable finance disclosures regulation.
Speaker: And one of the points was, is it really the smart thing to do to include scope three, given how
Speaker: much work there is to do on it.
Speaker: And the answer was, no, we need to be ambitious.
Speaker: We need to tackle this.
Speaker: There isn't any time to waste.
Speaker: And I think that's very much the regulators view on ESG.
Speaker: Whilst there's the need to ensure that investment vehicles do what they say on the tin, there's also the need to encourage investment.
Speaker: And the way to do that is to gain confidence and to get disclosures increased.
Speaker: So on the regulatory piece, Farnham, what's your view?
Speaker: I absolutely agree with both you and Michael.
Speaker: I mean, I think a carbon price is probably the most transformative single step that we could see.
Speaker: And, you know, when we have some debates with clients sometimes around, you know, the potential for
Speaker: over-regulation in the sense of the burden of reporting, the burden of disclosure.
Speaker: I mean, I think many of these things are mitigating around the fact that we don't have a really viable carbon price at the moment.
Speaker: Michael mentioned the $50 price.
Speaker: I think most companies' internal prices are now moving higher than that.
Speaker: And so I think once we have that in place,
Speaker: A lot of this then becomes built into strategic thinking and companies will respond with the innovations and the research and development that they need to be viable in that scenario.
Speaker: In the absence of that, we are looking at the regulations around disclosure.
Speaker: I think the UK's move to make climate risk disclosure mandatory has been extremely positive.
Speaker: And, you know, seeing it also trickle down only from the issuer side, but also as per yesterday's announcements among pension funds.
Speaker: I think that creates a kind of mutual reinforcing circle where everyone's asking for the same data and everyone's asking for the same metrics.
Speaker: And so it's not one company having to stick their head above the others, but rather the whole industry is moving in the right direction.
Speaker: Great.
Speaker: Thanks.
Speaker: And Patrick?
Speaker: Yeah, I mean, from my side, anything around disclosures and standardization around disclosures and transparency is very key because it provides the incentives to the market participants essentially to change their view.
Speaker: And it also provides the shareholders, be it anyone in the chain, activists, to actually challenge them based on data.
Speaker: And I think that really is transformative in terms of behavior.
Speaker: I mean, we've seen TCFDs.
Speaker: Now there is work around TNFDs, which are more around natural capital.
Speaker: SFDR for the asset management space where, you know, you have to label your products and so on.
Speaker: All of these things clearly, you know, provide strong incentives.
Speaker: Similarly, on the incentive side of things, capital requirements, not something we have seen yet for banks depicted, but the EBA has alluded to it in some of the papers, and it's something that might come.
Speaker: And that could be very powerful as well if you have higher capital requirement for non-GIN assets or gray assets.
Speaker: And that will also probably accelerate the move because it will cost you money not to do the right thing.
Speaker: And anything around net zero mandate for central banks like BOE will be also, I think, a very powerful tool.
Speaker: So those are things, I mean, alongside obviously carbon pricing that was discussed by Michael and Farnam, those are the things that really can move the dial.
Speaker: Wonderful.
Speaker: Thank you very much indeed, Farnam and Michael and Patrick.
Speaker: Thank you for sharing your insights with us today.
Speaker: This has been the Markets and Securities Services Outlook, a podcast miniseries produced especially for HSBC Global Viewpoint.
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