SustainaWeekly - A more gloomy outlook for EU spending towards climate next year

ESG Bonds: European governments have been increasing over the years their climate ambitions, but this requires a great amount of investment funds. However, at the same time, the fiscal policy is now turning in Europe and EU countries are pressured to reduce deficits and debt levels for the coming years. Also a political landscape more skewed to far-right will make it harder for green investments to increase.

Strategist: When bank bond issuers face ESG risks such as climate change, this should be translated in the market through significant pick-up on longer maturities. Based on that, we use the ValueCo ESG opinions to assess where banks stand with regards to such risks. Our analysis indeed reveals a relation between such opinions and the steepness in the curve, but that relationship is more clear when we purely focus on the environmental part of such opinion.

Sectors: We have done a trilogy on CCS. Our first publication was on the technologies and techniques to capture carbon (see here). Then we focussed on how to transport CO2 (see here). In this SustainaWeekly the central question is how to store CO2? We answer what kind of state CO2 needs to be in order to store it. But also in what geological sinks CO2 can be stored and what trapping mechanisms are used. In the future we will also focus on CO2 utilization, direct carbon capture and mobile carbon capture.

ESG in figures: In a regular section of our weekly, we present a chart book on some of the key indicators for ESG financing and the energy transition.

ESG sovereign bond supply to stall in the coming year

• Following three years of unprecedented sovereign bond supply, ESG bond issuance also benefited from this trend in the past years

• However, the fiscal policy is now turning in Europe and EU countries are now pressured to reduce deficits and debt levels for the coming years

• This clearly contrast with the urge of governments to spend more on climate and energy transition

• Furthermore, the political landscape in Europe is now further skewed to the far-right parties which do not aim to increase but rather decrease spending in green investments

• Current negotiation on the new EU fiscal rule is our last hope to see a boost in green investments in Europe

• The NGEU green bond supply is also stalling and is far from meeting its yearly issuance target

Over the past three years, we have seen ESG government bond supply develop and increase its size in the sovereign debt market with its issuance portion to reach as high as 10% in the Dutch debt market for instance. As we expect a similar gross supply outlook in 2024 than 2023, ESG bond issuance should also amount to a similar levels than this year for most EGBs. However, the risk points to the downside, particularly from 2024 onward, as the political will and fiscal capacity of most European governments tend to signal a stabilization and even a decrease in green investments. And thus potentially lower ESG bond supply going forward.

The end of fiscal stimulus in Europe is likely to affect ESG bond supply in the coming years…

Despite increasing investment needs for the climatetransition, the European governments still struggle to make space in their budget to increase green investments. The most recent example is in Germany where the German Constitutional Court has rejected the reallocation of EUR 60bn from the Covid plan unspent to a Climate fund, ultimately impacting its funding plan for the years to come. This EUR 60bn immediate cancellation has a significant impact on Germany’s Climate and Transformation (KTF) fund which previously planned to spend more than EUR 177bn over the next three years to speed up the country’s industrial modernization and green energy transition. The Court judged that the unused debt cannot be transferred into an off-budget fund for initiatives like climate investments. This is an ironic situation, given that Germany was blamed for not putting enough financial effort into their Climate agenda, given the size of its economy. Indeed, the Climate Council warned earlier this year that Germany must increase its efforts and not push off the responsibility to Europe. However, this is more difficult to put into practice. The rest of the Eurozone will also have difficulty in expanding their budget further.

Despite the rise in green bond supply over the past years, this is still a niche market in the sovereign debt area. On average, it represents between 3% to 5% of EGB debt issuance. Looking at the big-6, the ESG bond issuance amounted to almost EUR 50bn in 2023, slightly higher than in 2022 (see chart above). We expect a similar amount next year but with risk to the downside particularly due to the uncertainty over the German budget for 2024, which could lower borrowing requirement further.

This year marks the end of the fiscal stimulus by European governments. The EU has put pressure for European countries to restore fiscal stability and reduce debt levels starting next year. As such, the political discussions have now turned to fiscal tightening. This signals lower government spending in the coming years and thus, likely to impact green investments in turn. Unless government spending for the Climate is to be recorded as an ‘’off-budget’’ (as German government attempted to do and failed) and exempt from the debt safeguards, we expect aggregated green bond supply to stall and potentially even decrease in the coming years. In addition, the significant rise in borrowing costs over the past two years also made investments less affordable and now puts another important financial constraint on European governments - which is interest payments. For highly indebted countries like France, interest costs will indeed become one of the top 3 government expenses next year and we estimate interest costs to be as high as EUR 70bn by 2025 (which would represent the biggest government expenses item). Despite an increasing share on the French government budget allocated to Climate, the government spending remains lower with EUR 40bn allocated in 2022. This is unlikely to increase much further as the government now even get lesser fiscal space to do so.

In the end, there is pressure for European governments to reduce their government spending while increasing green investments significantly over the coming years. Which of those two will prevail is the real question and the answer to it will set the trend for ESG bond issuance going forward.

… as well as the political landscape

Political elections can also significantly affect the climate mitigation progress. Next year represents an important driver on the direction that national climate policy will take for the coming years. The way countries develop determines their capacity to push forward their climate agenda and achieve other sustainable development objectives simultaneously, as highlighted by climate experts in the IPPC. Unfortunately, the recent and future upcoming political elections do not point towards positive development in this field. Indeed, the recent election in the Netherlands serves as a good example where a climate sceptic party (PVV) has completely turned around the political landscape and has in the meantime put at risk the current climate policy of the country. As discussed in our global outlook, the risk is for a delayed transition if a right-wing coalition led by Geert Wilders is to take place. Indeed, Geert Wilders, who is the leader of the PVV party, is known for his climate skepticism and the desire to cut spending on renewable energy. Therefore, green investments will likely stagnate and even decrease under this coalition.

Turning into a European picture, the EU election to be held in June 2024 also points to a progress of far-right political parties in the EU parliament, which increases concerns around the future EU climate policy. Given that some far-right parties are opposed to spending on green investments, this could indeed add an additional delay on national climate policies and the implementation of the EU green deal. A topic we also discuss in more details in our global outlook. In our view and based on current polls, it is unlikely that the EU Green deal will be changed or abandoned. However, the most likely scenarios tend to point to a rather weaker climate stand within the EU and thus the risk of becoming less proactive in a critical decade for limiting the impacts of climate change.

However, there is one positive among this gloomy green outlook: it is the new EU fiscal rule currently in negotiation. The EU finance ministers are currently looking at Spain’s proposal, who holds the EU presidency, where the aim is for governments to rein deficits and debt while leaving room for green and defense investment. A potential agreement on a new EU fiscal rule could indeed give a boost to green investments in Europe.

The EU also falls behind its NGEU green bond issuance target

Following the pandemic, the EU launched the NextGenerationEU (NGEU) program to support Europe’s recovery with a total envelope of EUR 800bn to be issued between 2021 and 2026. From this, the EU targeted to finance 30% of this program via green issuance. As a result, the size of the borrowing is expected to be around EUR 180bn per year, which translates into an NGEU green bond issuance of EUR 45bn per year. However, this is far from the current and previous EU green bond issuances, as shown in the graph below. So far, the EU raised almost EUR 50bn in green bond format, which remains below European governments like Germany with an amount outstanding at EUR 55bn, albeit the growth trend progressing much faster than in any European governments. The uncertainty remains on whether this trend will persist in the future.

In 2022, the EU issued about EUR 24bn of green bonds, which was higher than Germany and France's green issuance combined. However, given the lower than expected EU issuance this year, the green bond supply dropped in 2023 with only a total of EUR 12.4bn raised. Again, very far from the EUR 45bn yearly issuance if the EU were to meet the 30% target.

If the EU were to continue with the EUR 800bn envelope announced at its launch (which seems unlikely), this would mean that more green bonds will be printed between 2024 and 2026. However, this is not our view, given the EU disbursements delay and based on what EU member states currently requested from the recovery facility (RRF). Therefore, we expect EU green bond issuance to be lower than previously expected.