Comment: Europe will lead the way in climate-friendly investing

Comment: Europe will lead the way in climate-friendly investing

With a second wave of coronavirus and lockdowns now under way, questions about the resilience of the eurozone economy will be prevalent in the minds of investors. Despite encouraging news of two potentially effective vaccines, it will naturally take time for them to roll out, writes David Zahn.

There are arguably positives ahead for Europe, not least the region's unprecedented solidarity in terms of support packages, both monetary and fiscal. Furthermore, there is widespread agreement that climate change must be at the core of future eurozone policy.

The outlook for the eurozone is undoubtedly precarious. The bloc is beset with a new wave of covid-19 infections, negative interest rates and deflation. Although third-quarter 2020 gross domestic product figures showed a strong recovery, the prognosis is less optimistic amid increasing predictions of a contraction in the fourth quarter.

There are positives ahead for Europe, not least the region’s unprecedented solidarity in terms of support packages, both monetary and fiscal. Furthermore, there is widespread agreement that climate change must be at the core of future eurozone policy."

For 2021, the European Central Bank (ECB) will need to maintain its accommodative stance, with a continuation of low rates and further asset purchases.

Climate-friendly agenda
On a brighter note, there is anticipation for further positive developments in the European green bond market. The significant impact of climate and environmental changes across the globe has become increasingly apparent. The result in financial markets has been a corresponding increase in demand for investments that can help fund projects with positive environmental and/or climate benefits.

The ECB will, in the year ahead, is likely to continue to be a leading advocate of green bonds. Since taking over the presidency of the ECB, Christine Lagarde has consistently pushed for environmental issues to be an essential part of monetary policymaking, with climate change a "mission-critical" priority for the central bank.

Given her commitment to this agenda, the ECB will remain a willing buyer of green bonds into next year and beyond.

Given these tailwinds, there is the expectation of further expansion of the green bond market in 2021. Germany has already issued a 10-year green sovereign bond that met with record demand.

Furthermore, it intends to create a green bond yield curve by issuing green sovereign bonds in the additional maturities (i.e., two, five and 30 years) of a conventional yield curve, which is an important step. The creation of a benchmark curve for the asset class would allow investors to trade these bonds more freely and help the green bond market to expand.

Looking ahead to 2021, the eurozone will also be supported by the actions of the European Union (EU). The outlook for the region was bolstered considerably in late July when EU leaders finally reached an agreement on the €750bn covid-19 rescue plan initially proposed in May. The approval of this package bodes well for the European economy.

The EU will begin significant issuance in 2021, a move that should reduce the risk premium on European bonds, benefiting both government and corporate issues. The EU will also be at the forefront of the climate-change agenda.

Around 30% of the EU's rescue plan and €1 trillion of its seven-year budget are earmarked for initiatives directed at fighting the detrimental impacts of climate change.

Slow recovery, yet grounds for optimism
The European Commission (EC) has also made a pledge to decarbonize the economy, with a vision of zero net greenhouse gas emissions by 2050. In her State of the Union speech earlier this year, EC President Ursula von der Leyen proposed an even more ambitious target of achieving a 55% reduction in emissions by 2030 and suggested that €225 billion of green bonds should be issued to aid climate-friendly initiatives. If agreed by member states, this would consolidate Europe's position as the leading issuer of green bonds.

Despite these positive developments, our optimism is cautious. The focus for the coming year will be getting the eurozone economy back on track. Many hurdles lie ahead and, therefore, we do not foresee a swift European economic recovery.

It will probably take several years to return to pre-pandemic levels. Yet, for us, the building blocks are now in place from the fiscal and the monetary sides, and we believe these measures should help support European bond markets for the next two or three years.

David Zahn is head of European fixed income and senior vice-president, portfolio manager at Franklin Templeton

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