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Sustainable investors, it’s time to talk about Transition bonds

Sustainable investors, it’s time to talk about Transition bonds



The EU has embarked on a mission to make Europe the first climate neutral continent by 2050. Rather unnoticed amongst COVID-19 headlines, the EU parliament approved the unified EU Green Classification System, also known as the EU Taxonomy for Sustainable Activities, on the 18th of June and turned it into law. A core pillar of the new regulation is to outline whether an economic activity qualifies as a green investment or not, so providing a clear industry threshold for green financing transactions. While the technical working group is still defining the screening criteria for certain segments of the market, it is clear that the eligibility criteria set are stringent. Undoubtedly, this is the right thing to do if we want to achieve the challenging goal of limiting global warming to 1.5 degrees above pre-industrial levels.

Global energy demand is set to continue to grow over the next 30 years, driven by a rising population and economic expansion. And while renewable solutions continue to see their market share increase, fossil fuels are still expected to make up at least 50% of the global energy mix in 2050 even under the most optimistic scenario, according to research from Barclays. The implication of this is that achieving a low-carbon world requires existing businesses, in particular brown industries, to decarbonize and mitigate climate risk.

The hurdle for carbon-intense businesses to issue green bonds remains high however. Such issuers fear coming to the market with a green bond and being criticized for it. It comes as no surprise that oil and gas names reflect a weight of only 0.47% in the BofA Merrill Lynch Green bond index, while their index weight in the BofA Merrill Lynch Global Corporate index is more than 8%. Despite this, I would argue that companies operating in brown industries are playing an important part in the energy transition we need. Many of them are sizable players, with large capital structures and research and development functions in place to accelerate the much-needed change. Just last month, Total bought a 51% stake in Seagreen 1, an estimated £3 billion offshore wind farm project in the North Sea. Not many players have the financial firepower and the ability to take on the construction risk for such a major project.

But what about activities that cannot be classified as green, yet play an important role in reducing a  company’s greenhouse gas footprint? How can the investment industry encourage such behaviour for companies where the core of their business is not (yet) compatible with green financing?

One possible solution to allow carbon-intense industries to receive funding from the sustainable investor base is Energy Transition bonds. These are bonds issued with the purpose of enabling a shift towards a greener business model. So far, this idea remains in its infancy, with only half a dozen such bonds launched. Last month, Italian gas transportation business Snam launched its first official Transition bond via a €500 million deal. The proceeds will be used to finance eligible projects related to energy transition as defined by the company’s Transition Bond Framework. For example, these proceeds can be tied to renewable energy projects by making gas pipes hydrogen ready, or to energy efficiency programmes by installing heaters with more efficient technologies to reduce methane emissions. The new deal was welcomed by bond investors, and was three times oversubscribed upon issuance.

Having said that, fixed income investors have already had their eyebrows raised in the early days of the Transition bonds market. In 2019, a beef producer issued a Transition bond with the aim of using those funds to buy cattle from suppliers that had agreed not to destroy more rainforest. Many would argue that the company shouldn’t be buying cattle coming from deforested areas in the first place.

This highlights the importance of having checks and balances in place, and is a call for industry-wide Transition bond standards. Market participants need a framework which outlines the eligibility criteria for the use of proceeds of such Transition bonds, including the minimum energy improvements that need to be achieved, how this is measured and reported, and the extent to which such a transaction must be linked to the issuer’s wider transition strategy. Only this will gain investors’ confidence and trust, and allow Transition bonds to become a more accepted and deeper market place. The EU taxonomy will provide some valuable signposts here to help measure whether a company’s planned use of funds is good enough to qualify as a Transition bond. If done rightly, Transition bonds can offer an important additional asset class for issuers alongside Green bonds, and with that help to prevent greenwashing in the green bond market.

With the right framework in place, energy Transition bonds could be the next evolution in allocating capital towards a low-carbon economy, close an important gap and help mobilize more assets to tackle climate change. Issuers can get better access to an increasing sustainable investor base, while bond investors would see their opportunity set increase substantially, all leading to a greater impact in mitigating climate risk. A win for bond investors, issuers and the planet alike.

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Defense Stocks Fall As Paralyzed House With No Speaker Puts US Ukraine Aid At Risk

Defense Stocks Fall As Paralyzed House With No Speaker Puts US Ukraine Aid At Risk

On Tuesday evening, Kevin McCarthy, a Republican, was voted…



Defense Stocks Fall As Paralyzed House With No Speaker Puts US Ukraine Aid At Risk

On Tuesday evening, Kevin McCarthy, a Republican, was voted out (216-to-210 vote) as the Speaker of the US House of Representatives. Hardline Republicans were angered by McCarthy's willingness to fund Ukraine's war while arguing that the money could have been better spent to protect the southern border and restore law and order in imploding major US cities. The historic ouster of the speaker has weighed on defense stocks as traders anticipate challenges for the new speaker in securing further funding for Ukraine.

"The conservative revolt that ousted McCarthy has left the chamber in a state of paralysis until a new speaker is found. That raises the chances of a US government shutdown next month and a delay in further Ukraine assistance," Bloomberg said. 

In a note to clients, Goldman's Alec Phillips said: 

All other things equal, the leadership change raises the odds of a government shutdown in November, though with several weeks left until the deadline, many outcomes are possible. With many policy disputes remaining and a $120bn difference between the parties on the preferred spending level for FY2024, it is difficult to see how Congress can pass the 12 necessary full-year spending bills before funding expires Nov. 17. The next speaker is likely to be under even more pressure to avoid passing another temporary extension—or additional funding for Ukraine—than former Speaker McCarthy had been.

On Wednesday morning, European defense stocks, such as Rheinmetall, Saab, BAE Systems, and Leonardo, slid in the cash market. Bloomberg said this was because of the oustering of McCarthy. 

German arms manufacturer Rheinmetall dropped as much as 4.8%. 

Swedish aerospace and defense company Saab fell 3%. 

British multinational arms, security, and aerospace company BAE Systems slid 3.5%

And Italian defense contractor Leonardo was down 2%. 

In the US, uncertainty over funding will likely weigh on defense stocks. The S&P 500 Aerospace & Defense Index has been running into resistance for much of this year. 

Washington's endless stream of taxpayer funds to Ukraine has benefited the military-industrial complex. Now, it appears that the pipeline of easy money is in question due to the ouster of McCarthy. 

Tyler Durden Wed, 10/04/2023 - 08:50

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Something “Big & Stupid” Is Coming…

Something "Big & Stupid" Is Coming…

Authored by James Rickards via,

With debt levels reaching all-time highs in…



Something "Big & Stupid" Is Coming...

Authored by James Rickards via,

With debt levels reaching all-time highs in major developed and developing economies, and with debt-to-GDP ratios also in record territory (not including contingent liabilities such as Social Security, health care and other entitlements, which make matters worse), it seems time to consider just how nations will deal with this problem.

The debt crisis may not be imminent, but it is unavoidable. When it happens, it may present the greatest financial disaster of all time. It’s never too soon for investors to consider the fallout.

When you issue debt in a currency you print, there’s no need for default in the sense of non-payment.

You can just have the central bank buy the debt (by printing money). This is the situation today in the U.S., Japan, the U.K. and the European Monetary Union (the countries that use the euro). They all have huge debt burdens, but they all have central banks that can simply buy the debt by printing money to avoid default.

Non-Payment Is Not the Issue

There are many bad consequences to printing money and storing up debt on central bank balance sheets, but non-payment of debt is not one of them. This is the mantra of the Modern Monetary Theorists (MMT) and their thought leader Stephanie Kelton.

In my view, MMT is garbage as economic policy, but the no-default tenet is valid. George Soros says the same thing.

That said, we are well past the point where the debt can be managed with real growth. That threshold is about a 90% debt-to-GDP ratio. A 60% debt-to-GDP ratio is even more comfortable and can be managed.

Unfortunately, the major reserve currency economies are all well past the 90% ratio as are those of many smaller countries. The U.S. ratio is 134%, an all-time high. The U.K. ratio is 102%. France is 111%. Spain is 112%. Italy is 145%.

China reports a figure of 77% but this is highly misleading because it ignores provincial debt for which Beijing is ultimately responsible. China’s actual figure is over 200% when provisional debt is included.

The champion debtor is Japan at 261%. The only major economy with a halfway respectable ratio is Germany at 67%. It’s Germany’s misfortune that they are probably responsible for the rest of Europe through the ECB Target2 system.

All these countries are headed for default. But we must consider the different ways to conduct a default.

There are three basic ways to default: non-payment, inflation and debt restructuring. You can take non-payment off the table for the reason mentioned above — you can always just print the money.

The same goes for restructuring. Inflation is clearly the best way to default. You pay back the money in nominal terms, but it’s worth very little in real terms. The creditor loses and the debtor countries win.

Nice and Easy Does It

The key to inflating away the real value of debt is to go slowly. It’s like stealing money from your mother’s purse. If she has $50 and you take $40, she’ll notice. If you take one dollar, she won’t notice. But a dollar stolen every day adds up over time.

This is what the U.S. did from 1945–1980. At the end of World War II, the U.S. debt-to-GDP ratio was 120% (about where it is now). By 1980, the ratio was 30%, which is entirely manageable.

Of course, nominal debt and GDP soared, but nominal GDP went up faster than nominal debt, so the ratio fell. If you can keep inflation around 3% and interest rates around 2% and exert fiscal discipline (which we did under Eisenhower, Kennedy, Nixon and Ford), the nominal GDP will grow faster than nominal debt (due to the Fed capping rates).

If you improve the ratio by, say, 2% per year and keep it up for 35 years (1945–1980), you can cut the ratio by 70%. That’s what we did.

The key was to do it slowly (like stealing from your mom’s purse). Almost no one noticed the decline in the real value of money until we got to the blow-off stage (1978–1981). But by then it was mission accomplished.

So there are two ways to deal with excessive debt: fiscal discipline and inflation. From 1945–1980, the U.S. did just that. If you run inflation at 3% and interest rates are 2%, you melt the real value of debt. If you exert fiscal discipline relative to GDP, you decrease the nominal debt-to-GDP ratio.

We did both.

The reason the debt-to-GDP ratio is back up to 134% is that Bush45, Obama, Trump and Biden ignored the formula. Since 2000, fiscal policy has been reckless so the formula doesn’t work. The problem isn’t really “money printing” (most of the money the Fed prints just comes back to the Fed as excess reserves, so it doesn’t do anything in the real economy).

The problem is that nominal debt is going up faster than nominal GDP, so the debt-to-GDP ratio goes up. This dynamic will be made much worse by the huge increase in interest rates over the past 18 months.

You can’t borrow your way out of a debt crisis. We have also been unable to generate much inflation. Inflation ran below 2% for almost all of the 2009–2019 recovery.

Japan Writ Large

Looking at the global picture, it’s important to understand that Japan is just a bigger version of the U.S. They don’t have fiscal discipline and they can’t get inflation to save their lives. The only way out for Japan is hyperinflation, which will come but not yet.

Japan can probably keep the debt game going for a while. The crash will come when the currency collapses. When I started in banking, USD/JPY was 400. Those were the days!

A debt crisis is on the way. Something big and stupid (in the words of the brilliant analyst Stephanie Pomboy) is coming from policymakers to address the issue. But the solution won’t be a policy and it won’t be a plan. A crisis will just happen almost overnight and seem to come from nowhere.

But it will come.

Tyler Durden Wed, 10/04/2023 - 09:45

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UK Has Run Out Of Vital Weapons To Give Ukraine

UK Has Run Out Of Vital Weapons To Give Ukraine

The hits just keep coming: a senior British military source has told The Telegraph that…



UK Has Run Out Of Vital Weapons To Give Ukraine

The hits just keep coming: a senior British military source has told The Telegraph that the UK has depleted available military equipment to give to Ukraine. Unlike the US or Poland at this point, it's not a question of funding or political will, but the British military has simply run out of vital arms and ammo to give, apparently.

"We’ve given away just about as much as we can afford," the official told the paper, explaining that all along the UK had encouraged other allies to keep arming Kiev.

Getty Images

"We will continue to source equipment to provide for Ukraine, but what they need now is things like air defense assets and artillery ammunition, and we’ve run dry on all that," the official added.

The shortage was revealed after controversial remarks given by recent Defence Secretary Ben Wallace

The comments come after Ben Wallace revealed that he asked Rishi Sunak to spend £2.3 billion more on support for Ukraine before he resigned as defence secretary last month.

Mr Wallace warned that the UK had been overtaken by Germany as the biggest European military donor to Ukraine as he called for the 50 per cent increase on funding that the UK has committed so far.

And now the public spat is yet another setback for the pro-Ukraine war cause, as The Telegraph underscores in saying, "The Western alliance has suffered a series of blows in recent days, with support for Ukraine dropped from a US stop-gap budget bill, election success for a pro-Russian party in Slovakia and rows between Poland and Kyiv over grain supplies."

These trends suggest NATO support and unity is fracturing, given also the most powerful country in the world is in a severe political fight, with the fate of future billions for Ukraine on the line. Biden still tried to 'assure' allies in phone calls on Tuesday.

And now the UK's resolve could be fracturing too. Prime Minister Rishi Sunak's reaction was that he would not waver:

Last night a senior military source told The Telegraph that the onus should not be on the UK to provide the “billions” Mr Wallace has called for.

“Giving billions more doesn’t mean giving billions of British kit,” they said, adding that the UK had a role to play in “encouraging other nations to give more money and weapons”.

...On Monday Mr Sunak was forced to insist that the UK’s commitment to Ukraine would not “waver” in the light of Mr Wallace’s comments.

The last months have seen Ukraine undertake a series of high-risk major operations against Russian-controlled Crimea, including significant strikes on the naval port of Sevastopol - including docked ships, submarines, and even the headquarters of Russia's Black Sea Fleet.

The latter strike reportedly used UK-made Storm Shadow cruise missiles. They are effective, and yet such an advanced UK-made missile is clearly in short supply, not to mention very expensive, at over $3 million per unit.

Tyler Durden Wed, 10/04/2023 - 09:30

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