Putting the Green in Gilts.
This section of the article has been written by Christian Porter,
Investment Associate at Kuros Associates.
In a bid to strengthen Britain’s position as a global financial hub, along with reinforcing the nation’s low-carbon credentials after the incoming Brexit decision, Chancellor Rishi Sunak has outlined plans for the UK’s first-ever green gilt, which has long been demanded by responsible investors. This comes on the back of a weak market for the UK Government’s debt, which hit unprecedented lows in 2020, with the Debt Management Office (DMO) offering their first negative-yielding gilt ever in May this year.
Although these securities do not offer investors the high returns achievable by equities, the macroeconomic picture as we come out of lockdown predicts that inflation is on its way. In response to this, assets such as gold and Gilts can provide a hedge against this. In the world of responsible investment, current ‘non-green’ Gilts continue to cause debate as to their inclusion within ESG (Environmental, Social, and Governance) portfolios. Let's take a look at what Gilts are and both sides to the argument.
WHAT ARE GILTS?
The official definition by the United Kingdom (UK) Debt Management Office (DMO) is that a Gilt, or Gilt-edged security, is a "UK Government liability in sterling, issued by HM Treasury and listed on the London Stock Exchange". The current makeup of the UK Gilt debt is divided between conventional and index-linked. Conventional Gilts are a liability that pays a fixed coupon semi-annually until maturity, upon which the investor received the principal required to purchase the debt originally. Index-linked Gilts offer the same regularity of coupons, along with the repayment of principal at maturity but this is adjusted to the UK Retail Prices Index. The purpose of this is to provide a real return to investors, adjusting payments in relation to inflation.
'The UK Government has never missed a coupon or principal payment for Gilts'
At the end of 2019, the Treasury's debt weighting was 72% towards conventional Gilts, worth approximately £1.1 trillion. The remaining 28%, worth a total of £433 billion, is made up of Index-Linked securities. Gilts offer attractive qualities to investors, with any debt issuance being fully backed by the UK Government. As a result, there has never been a missed coupon or principal. One reason for this is the ability of Central Banks to print money in order to meet requirements regardless of economic situations, which isn't possible for corporate or municipal debt.
GILTS – GREEN OR NOT?
Discussions continue to formulate around whether Gilts should be excluded via ethical screens or not. Certain investors claim that effective Governments, such as the democratically run United Kingdom, will use capital that best benefits its Citizens. As such, any investment into UK debt will arguably lead to a social impact that benefits the wider society.
In contrast, other investors are concerned with how the proceeds are used from Gilts, as debt is not ring-fenced for specific purposes. Essentially, though the Government is likely to act in a way that benefits the public, there are certain areas of expenditure that would cause concern. For example, the Public Sector is predicted to spend £29 billion on defense over 2019-2020. This is a widely accepted negative screen for many funds on ethical grounds.
GREENER GRASS AHEAD
Investors are putting increasing pressure on the Government to issue green Gilts, which looks to be fast approaching. These are Government bonds whose proceeds would be earmarked for specific projects with an environmental or social benefit. This would remove the concerns of how capital raised by the UK Government is invested. One MP that is championing the issuance of green debt is Gareth Davies, Conservative MP for Grantham and Stamford.
"As we come out of this crisis, the UK Government should issue a sovereign green gilt to specifically fund capital investment in infrastructure that will help stimulate the British economy after the coronavirus outbreak, creating new jobs, technology, and transport – while also continuing the mission to become a net-zero emission nation by 2050." - Gareth Davies, MP
Other countries lead the way, with The Netherlands, France, Poland, Ireland, and Belgium already issuing sovereign green bonds, with Germany and Italy disclosed they will soon follow.
As of November 2020, the UK Chancellor has now announced the proposed issuance of the Government’s first green bond in 2021, which will ringfence capital raised to be used towards overcoming climate change, along with improving and creating green infrastructure and jobs. The driving aim behind this is to help tackle climate change risks, whilst transitioning to a net-zero economy. This signals a significant step forward for The Treasury, which fairly recently stated that it would continue to monitor the development of green debt but only pursue it after meeting the following benchmarks; value-for-money criteria, enjoy strong and sustained demand in the long-term and be consistent with the wider fiscal objectives of the Government.
PERCEPTIONS OF GREEN
With green gilts on the horizon, issues stemming from ethical portfolios around how capital is allocated could soon be tackled. For ‘traditional’ gilts, it's important to understand your personal perceptions of their responsible investment credentials and from there you can go about selecting or screening them from your portfolio.
At Kuros, we understand how important ESG is, but we also understand that clients place greater value on different issues. We aim to provide investment strategies that not only deliver financial returns but also meet the responsible investment requirements of our clients. If you would like to learn more about our ESG offering, then please get in touch.