Barclays bolsters UK’s first green sovereign bond issue

It took the UK some time to get around to issuing its first green gilt, or sovereign bond, but the wait seems to have been worth it. The result was the largest green bond deal to date, on the back of the largest-ever green bond order book. Barclays was a joint lead manager.

Despite recent political and economic uncertainty, the UK remains in the premier league of sovereign issuers. “It’s a member of a small, unique group – with the US Treasury, Germany and Japan – who are truly benchmark issuers for major markets,” says Lee Cumbes, Barclays’ head of debt capital markets and public sector, Europe, the Middle East and Africa.

As issuers, they have all been busier than usual while their governments try to balance the economic effects of the Covid-19 pandemic. The UK’s Debt Management Office (DMO) has been as busy as any of them, given the scale of UK emergency spending and the borrowing required to fund it.

Up, then down

The numbers tell the story. In the years immediately before the financial crisis of 2007-09, annual gilt financing totals hovered between £50bn and £65bn. Then, in financial year 2009/10, borrowing soared to more than £200bn, and did not fall below £100bn again until 2018-19.

Just as funding was returning to more normal levels, however, Covid-19 came, triggering massive financial support spending for businesses and individuals, health and social care. In 2020-21, gilt financing rose to £485.5bn, and the government has budgeted £295.9bn for the current financial year.

“The DMO was doing up to three or four transactions a week early this year,” Mr Cumbes notes. “Then, in the midst of that, to deliver a green framework – an important investment for the future – is a testament to how hard it has been working.”

Given the DMO’s mission to raise money at the lowest possible cost to the taxpayer, it did not openly consider green issuance until the cost benefits were unequivocal. “There have been cost savings [for green versus traditional bonds] for a couple of years, but they became more explicit in the summer of 2020,” says Mr Cumbes.

In November 2020, UK chancellor of the exchequer Rishi Sunak announced plans to issue an inaugural green gilt. It was later revealed that the UK would issue at least two green bonds in the 2021-22 financial year, totalling a minimum of £15bn. It would also issue green retail savings bonds, the first of their kind anywhere, and would report on “social co-benefits” of the associated expenditures.

The idea behind social co-benefit reporting is that green funding should not only generate ecological and climate benefits but should also improve people’s lives.

“Green bonds shouldn’t have an adverse social impact,” points out Susan Barron, Barclays’ global head of sustainable capital markets. “But the UK is the first to specifically highlight their co-benefits.”

Investing in renewable energy or clean transport, for example, would have a positive environmental impact but could also have social co-benefits such as creating jobs, Ms Barron says.

Green ambition

In June 2021, the UK Treasury and the DMO published the UK’s green financing framework which, in their words, set out an “ambitious climate and environmental agenda and [the government’s] vision for enhancing the UK’s leadership as the world’s pre-eminent green financial centre”.

The framework listed the six types of expenditure that will be financed by proceeds from the bonds. They are clean transportation, renewable energy, energy efficiency, pollution prevention and control, living and natural resources, and climate change adaptation.

Research company Vigeo Eiris provided a second-party opinion on the framework, concluding that it was “credible and impactful” and aligned with the latest green bond principles of the International Capital Market Association.

In another sovereign green first, the Carbon Trust was commissioned to provide a pre-issuance impact assessment on the intended allocation of proceeds. The report concluded that this expenditure was indeed aligned with the government’s climate targets and environmental policies.

“It’s an additional level of detail, so that investors can have a better understanding of the likely reporting approach, possible impact metrics and likely eligible expenditures,” Ms Barron explains.

The framework set the market bar higher with its definition of eligible green expenditures. One of the more questionable aspects of green finance is that it allows proceeds to be allocated to money that has already been spent, looking backwards instead of forwards.

The UK framework limits this refinancing of eligible expenditures to no more than one year prior to issuance, and promises that these will absorb no more than 50% of the proceeds.

“So at least 50% of the total must go to current and new financing,” Ms Barron says. “Until now, in the market generally, issuers have committed to refinancing expenditures incurred up to two or three years previously.”

Time to prepare

In July, the DMO hosted an international investor call on the framework, followed up by a number of virtual meetings with investors.

“Investors needed time to familiarise themselves with the framework,” notes Yumi Yang, Barclays’ head of sovereign, supranational and agency public sector syndicate. “Some investors also need internal approval for new ESG frameworks.”

Lead manager mandates were announced three weeks ahead of the transaction rather than the traditional two, to allow the investor base maximum time to prepare.

Barclays was one of the six mandated bookrunners. The others were HSBC and JPMorgan, both structuring advisers, with Citi, BNP Paribas and Deutsche Bank. Mr Cumbes likes to point out that Barclays has led seven of the eight benchmark European government green bond issues since 2017.

There was another global investor call, this time introduced by Mr Sunak himself. “This was well-attended globally,” Ms Yang says. “Not one investor said they wouldn’t come back because of the framework.”

The deal was launched on September 21 with indicative price guidance of 7.5 to 8.5 basis points (bps) over the yield on the 2032 reference gilt. In a new addition to the existing gilts curve, the bond had a 12-year maturity.

“The support was enormous,” Ms Yang reports. Within the first 30 minutes the order book had grown to more than £65bn, and guidance was set at 7.5bps. The books were closed only one hour after opening with 217 orders, totalling more than £100bn.

This was not only the largest order book to date for a green bond but also the largest ever achieved by the DMO. Its previous record was £82bn for a £12bn 0.375% 10-year transaction in May 2020.

Such was the investor appetite that the DMO felt comfortably able to set the size of the 0.875% bond (0.8721% yield on re-offer) at £10bn, making it the largest sovereign green bond then on record.

The so-called ‘greenium’ – the saving compared with the same bond in a traditional, non-green format – was estimated at 2.5 to 3bps, the largest so far in a sovereign green bond. That will save £28m over the life of the bond. The bond later tightened by another 3.5bps in secondary trading.

Global attention

The DMO is normally wary of releasing distribution statistics, but this time was happy to announce that international investors had taken 17% of the deal. That’s higher than their usual share, which is said to be closer to 10%.

“The transaction provided the DMO with an opportunity to capture new demand, both domestic and international,” says Ms Barron.

That was welcomed by the DMO, which said that the decision to go for a 12-year maturity had been supported by a very high-quality order book, while successfully attracting new investors to the gilt market.

It subsequently announced the syndicated launch of a new 32-year green gilt, to take place in the week beginning October 18.

Mr Cumbes thinks that the greenium will continue to improve, noting that green sovereign bonds continue to perform well in secondary markets. “There is greater public recognition of the fact that green assets can be both sustainable investments and better hedges for the future,” he says. “There is real climate change and, with it, comes real financial risk. I believe markets are ready to pay a premium to balance those risks.”