Tuesday, June 12, 2018

CPPIB Issues Green Bonds?

Jennifer Thompson of the Financial Times reports, CPPIB to become first pension fund to issue green bond:
The Canada Pension Plan Investment Board has announced plans to become the first pension fund in the world to issue a green bond.

The C$356bn CPPIB, which invests the assets of one of the world’s biggest retirement funds, said on Monday it had concrete plans to issue the debt instrument.

The Toronto-based fund said the move would “provide additional funding for CPPIB as it increases its holdings in renewables and energy efficient buildings as world demand gradually transitions in favour of such investible assets.”

The CPPIB plans to invest more than C$3bn in renewable energy and said wind and solar, sustainable water and waste management projects as well as buildings designated ‘green’ would be eligible to receive investment from whatever the eventual bond raised.

It provided no further financial details.

Green bond issuance has soared over the past decade, in part as environmental concerns move into mainstream investing practice. Annual issuance hit $155bn last year according to the Climate Bonds Initiative, a UK-based non-profit organisation, a figure which is expected to reach between $250bn and $300bn this year.

Poul Winslow, CPPIB’s senior managing director and global head of capital markets and factor investing, added:
The issuance of Green Bonds is a logical next step to CPPIB’s investment-focused approach to climate change, and we are pleased to be a pioneer amongst pension funds in this regard. The capital raised will help support strong, long-term investments in eligible green assets that position the Fund for continued success.
Maciej Onoszko and Scott Deveau of Bloomberg also report, Canada Pension Taps Green Bond Market to Fund Renewables:
Canada Pension Plan Investment Board plans to issue green bonds in Canadian dollars for the first time, joining a growing list of borrowers selling the debt to finance environmentally friendly investments.

“The issuance of green bonds is a logical next step to CPPIB’s investment-focused approach to climate change, and we are pleased to be a pioneer among pension funds in this regard,” Poul Winslow, senior managing director and global head of capital markets and factor investing, said in a statement Monday. “The capital raised will help support strong, long-term investments in eligible green assets that position the fund for continued success.”

CPPIB’s statement doesn’t specify the timing or size of the sale, but says the Toronto-based fund engaged the Centre for International Climate Research, which specializes in providing second opinions on the qualification of debt for green bond status.

CPPIB’s green-bond framework allows for investments in wind and solar energy, sustainable water and wastewater management, as well as green buildings. It plans to invest more than C$3 billion ($2.3 billion) in renewable energy as it prepares for an expected global transition to a lower-carbon economy.

Canada’s green bond issuance, totaling C$8 billion according to data compiled by Bloomberg, has recently been dominated by provincial governments, yet an increasing number of other issuers such as insurers and municipalities have been making forays into the market in recent months.

Manulife Financial Corp. in November became the world’s first life insurer to sell green bonds when it priced securities in Singapore dollars, and followed that transaction in May with the first corporate green bond in Canadian dollars since 2015. The city of Ottawa sold green bonds in November, while Toronto seeks to follow suit in the second half of this year.

The province of Ontario is the country’s biggest green borrower with C$3.05 billion of securities outstanding that were sold in five transactions, including the country’s largest -- C$1 billion of seven-year bonds -- sold in January.

CPPIB invests on behalf of the Canada Pension Plan. The C$356.1 billion pension fund, which boasts the highest credit score at the three largest rating firms, started issuing debt in 2015. It has sold debt in the loonie, U.S. dollar and the euro.
Why is CPPIB issuing green bonds? It has over $356 billion under management and doesn't need the money so why is it issuing green bonds?

Cynics will claim it's just a green gimmick, another case of Canadian pensions cranking up the leverage to boost their returns and executive compensation.

Now, let's all take a deep breath in and out. I'll explain to you exactly why CPPIB wisely chose to issue green bonds.

First, it has nothing to do with leverage. CPPIB will invest $3 billion out of a total $356 billion so leverage isn't the reason behind issuing green bonds.

Second, it has everything to do with efficient use of capital. When a corporation issues a bond, it uses that money to buy back shares, invest in capital equipment or make a strategic acquisition, among other things.

When a pension issues a bond, any bond, it incurs liabilities and needs to invest that money wisely to earn a higher rate of return.

In the US, rating agencies are targeting underfunded public pensions and many of these state and local governments with chronically underfunded pensions are responding by kicking the can down the road, issuing pension bonds to invest and try to make up their shortfall.

It works like this. US state or local governments emit $100 million in pension obligation bonds, pay out 4.5% (assuming rates don't rise a lot) to investors and their public pensions use the proceeds to invest in stocks, corporate bonds, private equity funds and hedge funds to try to earn more than than that 4.5% being paid out (typically targeting a 7.5 or 8% bogey) to try to close the gap between assets and liabilities to improve its funded status.

And because a lot of the US state and local governments emitting pension obligation bonds are fiscally weak, their credit rating isn't very good so they need to pay an extra premium to investors to entice them to buy these pension bonds.

It's nuts when you think about it because they're taking credit risk (their own balance sheet can significantly deteriorate) and market risk (if interest rates rise or assets get clobbered), hoping they will invest wisely to earn more than what they're paying out to bondholders. This is why experts warn to beware of pension obligation bonds.

Are you with me so far? Great, because unlike US public pensions, Canada's large public pensions operate at arm's length from the government, enjoy a AAA credit rating because they're fully funded or close to it, they have world class governance, and are very transparent.

Their strong balance sheet and exceptional long-term track record allows them to emit bonds, any bonds, at a competitive rate as they receive a AAA rating, and then they can use those proceeds to target global investments across public and private assets all over the world.

So, issuing green bonds is nothing new, it's something old that only targets green investments, but the media reports make it sound like CPPIB is doing something way out of the ordinary.

It isn't. It's doing what it has done all along, what all of Canada's large pensions are doing, using their great balance sheet and long term track record to emit bonds as rates are still at historic lows and use those proceeds to invest across global public and private markets to earn a better rate of return.

And they're not jacking up the leverage, at least CPPIB isn't relative to its overall portfolio. It simply boils down to efficent use of capital. That's it, that's all.

Now, in this case, they label it "green bonds" so that other investors like US public pensions which cannot invest in private renewable energy markets as extensively as CPPIB and have a mandate to invest in renewable energy, can load up on these bonds.

Oh yeah, who do you think is going to buy CPPIB's green bonds? My money is on US public pensions, at least if they're smart and know what they're doing.

What is CPPIB going to do with the proceeds? It's going to expand its growing portfolio of wind farms and other renewable energy, focus on sustainable water and wastewater management, and invest in LEED platinum certified commercial real estate all over the world.

Go back to read last week's comment on why G7 investors are uniting on global initiatives where HOOPP's CEO Jim Keohane shared this with me on their real estate portfolio:
  • In terms of real estate, Jim told me 40 percent of greenhouse gases come from buildings so it's a major contributor to climate change.
  • HOOPP focuses on best environmental standards and takes energy efficiency in its real estate holdings very seriously. Why? Simply put, it adds to the bottom line and makes great sense from a fiduciary and environmental standpoint.
  • He gave me the example of One York Street, a joint project of Menkes Developments and HOOPP, which is their headquarters now. He said it achieved LEED Platinum certification, earning 89 points, the highest score ever awarded to a Toronto building and is the most energy efficient building in Canada.
  • Interestingly, this energy efficiency is good for HOOPP because operating costs were slashed by 60 percent, allowing them to lock in quality tenants for longer at lower leases. Tenants like Sun Life enjoy lower leases but also lower their carbon footprint which is what shareholders want. 
  • Jim told me the building is incredible and the quality of the air is unlike any other building where the vents are on the ceiling and air is "drawn down and sucked right back up" which leads to "stale air and people getting sleepy in the afternoon" (no, it's not just fatigue, the air quality in your building is terrible). At One York, "the vents are on the floor and each area can dial it up or down." 
  • That's great for a new building which HOOPP built from scratch with its partner but what about older buildings in HOOPP"s real estate portfolio? Jim told me they're working with property managers to make them more efficient by focusing on three areas: 1) reducing energy consumption, 2) reducing water consumption and 3) reducing solid waste and recycling more.
  • That's what HOOPP's seventh annual LEAP Awards were all about last night. Property managers were invited to give their best ideas on making properties more sustainable and energy efficient.
That conversation opened my eyes to real estate, showed me there is a lot more to a building than just space and leases.

Well, as you can see, it's not just HOOPP that's investing in top energy efficient buildings or trying to make its real estate portfolio energy efficient, other large Canadian pensions are also focusing on energy efficient buildings.

Again, green bonds are just a label, don't get enamored by labels, focus on the long term efficient use of capital. Yes, there is a specific renewable energy focus but at the end of the day, it all boils down to efficient use of capital. Period.

It doesn't mean CPPIB is going all green in its investments, far from it. CPPIB stills invests in the hydrocarbon economy, it doesn't have much of a choice and wouldn't be a good fiduciary if it didn't evaluate all investments that fall under its mandate to maximize returns without taking undue risk.

In fact, the Canadian Press reports that CPP Investment Board taking a look stalled Trans Mountain project:
The federal government’s financial adviser has raised the possibility of the Canada Pension Plan Investment Board becoming involved in the Trans Mountain pipeline project but there’s been no political pressure applied, CPPIB chief executive Mark Machin told a parliamentary committee Monday.

The Toronto-based fund manager and its peers will likely take a look at the stalled Trans Mountain project because there are a limited number of investment opportunities of its magnitude, but CPPIB has yet to begin a formal analysis or receive any confidential information, Machin told Commons finance committee.’

His testimony came less than two weeks after the government announced it would buy the project for $4.5 billion from Kinder Morgan, to ensure the pipeline will be completed, with the intent of selling it at a profit in time.

Machin insisted, in answer to a question by Conservative MP Pierre Poilievre, that there had been no contact between CPPIB and Finance Minister Bill Morneau or any other member of the Liberal government.

But Machin said that CPPIB has been approached by Greenhill & Co., a small investment bank that has been hired to advise the government on selling the Trans Mountain project.

“I believe they’ve approached every — a lot of — funds domestically and internationally,” Machin said.

“At this stage, we haven’t done any analysis. We’re still evaluating the situation. Obviously, we have an obligation to investigate and to assess any major investment opportunity that comes along. And to fully understand all of the risks, all of the potential returns and understand the fit for our portfolio as well.”

The issue of political pressure is relevant because the CPPIB was set up in the late 1990s to be an independent manager of funds on behalf of the Canada Pension Plan, an employer and employee-funded retirement system.

As of March 31, when CPPIB’s financial year ended, it managed a fund with $356.1 billion in net assets, up from $316.7 billion at the end of fiscal 2017 and $278.9 billion at the end of fiscal 2016.

Morneau has predicted the Trudeau government will have no difficulty selling the Trans Mountain pipeline expansion project after uncertainty about its future is resolved.

The federal government’s hand was forced by B.C. Premier John Horgan, who is waging a court battle over the federally regulated pipeline, which would carry diluted bitumen from Alberta’s oilsands to a sea port near Vancouver.

Machin told the finance committee that the Canada Pension Plan Investment Board has a mixed track record with pipelines and will use its usual approach when deciding whether to put money into Trans Mountain.

In general, he said, a major factor to consider is regulatory risks — pointing out that CPPIB and its co-investors in a European pipeline were caught by surprise when the Norwegian government made a significant change in the tariff regime — or pricing structure — shortly after the deal closed.

“We’ve been in legal proceedings for a number of years now,” Machin said.

“That is part of the regulatory risk. It’s a really critical part of due diligence to understand regulatory risk for any infrastructure investment.”

The federal government decided to buy Trans Mountain after Houston-based Kinder Morgan threatened to walk away from the pipeline expansion due to political uncertainty, particularly because Horgan’s New Democrat government said it will do everything in its legal power to stop the pipeline because of unresolved environmental concerns.

Machin told the committee that the CPPIB hasn’t made a formal evaluation of Trans Mountain “purely because it’s at an early stage and we haven’t got any confidential information, or any information, to assess the situation yet.”

The Ontario Teachers Pension Plan — another of Canada’s independent retirement fund managers — indicated last week that it had a financial obligation to take a look at the potential of Trans Mountain.
I recently went over whether Canada's pensions will eventually buy a stake in Kinder's pipeline and expressed my doubts that CPPIB will get involved:
[...] my hunch is the two main Canadian pensions interested in this project are AIMCo and OMERS and they can very well partner up to invest in it. AIMCo is independent of Alberta's government but it must want first dibs on a prized pipeline which will be the economic lifeblood of that province.

OMERS has a lot of experience managing pipelines so it would be a great partner to AIMCo on this deal if they were to buy it (the dollar amount would be too much for either pension to go it alone).

I thought the Caisse would be interested because let's face it, it has a great team in place to take over the construction of this pipeline but given that it wants to reduce its carbon footprint, I'm not sure it wants to get involved (but it's too bad since this is a great project for the Caisse's REM team to consider, minus all the political and regulatory hurdles).

I'm pretty sure CPPIB and OTPP aren't interested in this project, not at this time as there are too many risks. They prefer investing in brownfield projects (CPPIB) and will only invest in greenfield if they have a specialized team in place to help them manage the asset (OTPP).

All this to say, there is a lot of chatter on Canada's pensions investing in the Trans Mountain pipeline deal but I think we need to wait before jumping to any conclusions.

I guarantee you no Canadian pension will invest in this project unless they get the right terms to fulfill their fiduciary duty and achieve the return objective. Moreover, as you can read above, competition is intense because Brookfield Asset Management also expressed an interest and that firm is a global leader in infrastructure.
In the article above, Mark Machin raised an excellent point on regulatory risk as CPPIB did get burned on that Norwegian pipeline deal.

Of course, this is Canada and it is called the Canada Pension Plan Investment Board. Still, there are plenty of risks with this Trans Mountain pipeline.

I recently spoke to an infrastructure expert who told me:
 "The federal government has to move fast to set up a Crown corporation for this project but to do this, it needs to pay top dollar to attract top people to this project because pipeline project managers are expensive. If the Government starts capping compensation like they do with all Crown corporations, they won't attract the right people and significantly increase construction and operational risks."
This is why Canada's large pensions are taking a wait and see approach because the easy part for the federal government was to nationalize this pipeline, the hard part is to deliver the pipeline on time, within budget and up to the standards investors and Kinder will be looking for.

Anyway, in other news, CPPIB said on Friday it will invest $600 million in a unit of Jack Ma’s Ant Financial Services Group, operator of China’s biggest online payment platform:
CPPIB’s investment is part of Ant’s $14 billion fundraising announced on Friday.

Ant Financial, spun off from Alibaba Group Holding Ltd (BABA) before the e-commerce firm’s 2014 listing, has played a major role in shaping China’s financial technology landscape.
You can read CPPIB's news releases on the issuance of green bonds here and the Ant International deal here. Both of these investments are great long-term investments.

Lastly, just today, CPPIB announced a new Senior Managing Director, John Graham, a 10-year CPPIB veteran, is now responsible for leading the Principal Credit Investments, Private Real Estate Debt and the newly created Public Credit functions:
“For the first time in CPPIB’s history we are going to have all of our credit investors in one department,” says Graham. “Credit as an asset class is one of the largest globally and this change is going to provide the opportunity to have all of the experts together to build a global, diversified credit portfolio that maximizes value for CPPIB.”

The shift is crucial to support our strategic mandate to become an increasingly global investor and properly respond to the opening of credit markets in China, India and Latin America.

Graham notes those markets are less developed than credit markets in North America and Europe, and makes viewing credit through a broad lens increasingly important.

“We are going to have a mandate across the credit spectrum from investment grade to non-investment grade, and corporate to asset-backed lending,” he says. “It’s a broad mandate and we are currently developing a go-to-market strategy for new geographies, leveraging the breadth in a deliberate and methodical way.”

Graham adds this new approach to credit investing will differentiate CPPIB from organizations that house credit within regional departments, asset class groups (such as real estate), or separate it based investment grade and non-investment grade.

“When you invest in emerging markets, the lines between these asset classes – or these segments of the asset classes – are very blurred,” he says. “Having all investors within one department allows us to look beyond product labels and focus on the underlying risk/return trade-off.”

Graham says the department will continue to be a fundamental credit investor and ensure CPPIB is focusing on the creditworthiness of each individual investment.
Smart move, very smart. That's why CPPIB is ahead of the curve when it comes to integrated risk management.

I wish John Graham and his team the best of luck managing all these credit investments all over the world.

Below, Barbara Shecter speaks with Mark Machin, CEO of Canada Pension Plan Investment Board, on how the CPPIB selects long-term investments and their decision to substantially invest in renewable energy. Listen to Mark Machin, he's very bright and explains it beautifully.

Second, a clip from the European Investment Bank on what exactly is a Green Bond. Also, Bertrand Gacon, Head of Impact for Lombard Odier, talks about what a Green Bond is.

Fourth, EY’s Mathew Nelson talks about the explosion of the Green Bond market on the back of the Paris Agreement, as investors align themselves to a 2-degree world, and the emergence of new ESG investments.

As you can see, green bonds are nothing new and they're exploding across the world. I suspect other large Canadian pensions will follow CPPIB in issuing green bonds in the near future.

Lastly, while CPPIB issues an inaugural Green Bond, US state and local governments are issuing more pension bonds. Watch Thad Calabrese, NYU, and Kuyler Crocker, Tulare County Board of Supervisors, discuss why cities are investing in the market through the issuance of pension bonds.

If I had a choice between CPPIB's green bonds and US public pension obligation bonds, well you know where my money would be invested.





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