UK green bank to sell new bonds

An independent commission unveiled its recommendations yesterday for setting up a state-backed UK green investment bank. They include the creation of a new category of green bonds to satisfy a ‘real demand’ among pensions and insurers ‘for a new type of long-dated instrument’.

The Green Investment Bank Commission – an independent body set up to advise the government on the creation of a UK green investment bank – unveiled its conclusions yesterday on how the future bank should function and raise money to help enable Britain’s climate change policy.

UK green bank: targeting
pensions and insurers

Led by former Merrill Lynch European chairman Bob Wigley, the commission outlined how the bank could help foot the bill for a significant part of the £50 billion (€61 billion, $75 billion) per year the UK is said to need over the next decade if it hopes to meet its climate change goals.

The green investment bank plans to incentivise private sector investments in the renewable sector, particularly if “its action would serve to achieve a result that would not have otherwise been possible,” the report said. Where the private sector can lead and execute deals, it should do so with the bank providing minimal assistance.

Although it would be government-backed, Wigley suggested the bank should function on a commercial basis although it would include politicians in its advisory panel.

The report suggests the green bank should be split into two units – a UK fund for green growth and a banking division. The former will use public funds to directly invest in projects via grants, subsidies, low interest loans and early-stage venture capital. These public funds would come from existing government organisations that would be folded into the bank (£185 million) and the assets of several existing government-backed green funds (£2.1 billion).

The banking division would be funded with commercial bank money, the sale of green Individual Saving Accounts (ISAs) to retail investors, a levy on energy bills, the sale of government-owned assets and, significantly, the sale of a new category of bonds to pension funds and insurance companies.

These new green bonds aim to capitalise on pensions’ increasing appetite for “gilts and fixed interest bonds” as they move away “from equity into debt investment […] because of liability-driven strategies,” the report said.

Likewise, the UK’s £137 billion annuity market could also be capitalised since a “lack of supply of high-quality sterling bonds is driving such funds to invest in non-sterling assets […] creating a real demand for a new type of long-dated investment [..] in the A to BBB categories,” adds the report.

The green bonds could be a means to raise money for the bank itself by selling single project bonds, bonds directly funding asset portfolios, or secondary project finance loans bought from banks and bundled according to asset class. Or the bank could help mitigate risk for specific project debt via guarantees.

The creation of a green bond market “will take several years to produce a cashflow”, the report admits, and would have to overcome a number of constraints – bonds would have to be rated by external agencies and the market would have to be deep and long-dated enough to offer the necessary liquidity to allow investors to easily move in and out of it. In addition, it would also have to offer “long-term incentives” to channel institutional investment in the sector on a large scale, the report points out.