“I want to explore every avenue available in order to combat climate change” – Christine Lagarde
This statement, from the President of the European Central Bank in a recent video interview with the Financial Times, shows that COVID-19 has not halted the massive shift towards green policy initiatives within the Bloc. Instead, the green policy changes are likely to lead to an outperformance in the ESC funds, Automotive Sector and Energy Sector.
Lagarde stated that the ECB may look to use the $2.8tn asset purchase scheme to pursue green objectives.  Currently, 5% of the holdings from Corporate Sector Purchase Programme (CSPP) and Pandemic Emergency Purchase Programme (PEPP) are corporate green bonds. The ECB have previously expressed a keen interest in increasing their holdings of Green and Sustainable bonds.
Green bonds are a type of fixed income instrument, designed to raise money for new or existing projects that help to promote environmental goals.  Sustainable bonds are those which combine both green and social projects, such as tackling hunger and food security. The following chart from DZ Bank shows predictions for the market issuance volume of green bonds to reach US$1.5 trillion by 2023. 
Demand is ever increasing for these bonds as green policies shift trader sentiment towards sustainable initiatives, as well as environmentalists’ increased pressure to reduce “brown” bonds issued by carbon intensive companies. Although, there are strict guidelines and detailed reporting requirements for these projects, that lays out the non-financial return aspect of this asset. This subsequently inhbits the increase in supply relative to demand as many bonds do not meet the strict ESG investment criteria.  As a result, the ECB’s Asset Purchase Program is often used to invest in green bonds, leading to a strong likelihood that there will be an inflow of excess demand, driving up prices and triggering a sustained bull market rally.
Additionally, we can expect a positive effect on the performance of ESG mutual funds due to the increased inflows from investors seeking to capitalise on this trend. Research from Morningstar indicates this pattern as “sustainable funds also outpaced traditional funds during the market sell-off sparked by coronavirus in the first quarter, notching up average excess returns of up to 1.83 per cent”.  They also reported that ESG funds from 10 years ago had a survivorship rate of 77% compared to 46% for traditional funds, so it can be expected ESG titled indexes to consistently outperform in the following months as the ECB catalyses this trend.
The question should also be raised of how the green recovery plan is being implemented across various countries. Below is an evaluation of the actions of a selection of EU National Governments, alongside the potential impact on the Automotive and Energy Sectors.
Data collected by the ACEA (European Automotive Manufacturers Association) shows that after the first wave of the virus, between mid-March and May, the EU market declined by 41.5%, with car sales plummeting by more than 95% in major EU markets in May.  Since 13.8 million Europeans work in this industry and 11.4% of all EU manufacturing jobs are in the automotive sector, it is a strong possibility that there will be targeted economic support to limit unemployment levels over the next quarter.
“As we work on putting the wheels back in motion, we must look for win-win solutions, addressing the pressing environmental, industrial and broader societal needs,” – Sigrid de Vries, CLEPA Secretary General.
On 14th May, the European Commission held a meeting with Automotive CEO’s. It was expressed that the purpose of any automotive recovery measures will be to target investment in renewable energy carriers and infrastructure to boost industry growth through technology solutions.  As a result, fiscal measures in the form of tax benefits or purchase incentives for buyers have been implemented in 26/27 EU countries to stimulate electric vehicle sales, bar Lithuania. 
Additionally, out of the € 42 billion allocated to Germany’s green projects, around 22% will be allocated towards the automotive sector, with €2.5bn used to expand Germany’s charging infrastructure for electric cars. The French car industry will also receive a similar aid package, totalling roughly €8bn, to be invested heavily in Renault for electromobility.  As a result of the strong desire from the EU to push policies that accelerate the secular trend towards electric vehicles through supply chain innovation and sustainable growth within this sector, the automotive market is set for a strong recovery towards the end of this year.
The European Green Deal, published on 11th December 2019, detailed the overarching aim for Europe to become ‘Climate Neutral’ and reach net-zero greenhouse gas emissions by 2050. This initiative was reinforced with the recent Next Generation EU proposal to add €750bn to the European budget with the stated aim to:
“kick-start the European economy, boost the green and digital transitions, and make it fairer, more resilient and more sustainable for future generations”.
Since this initiative was introduced, Germany has allocated €11bn to subsidise renewable energy in 2021 and 2022, as well as €7bn to the development of a hydrogen strategy for industrial usage. France has directed €7bn of support to Air France with the condition that the “company should reduce its Co2 emissions by 50% by 2024 for domestic flights, it should renew its fleet with more efficient aircraft and use more biofuel”.
These new initiatives are designed to increase the availability and production of renewable energy sources, with cleaner fuels slowly becoming the new normal. The chart data from CSI Market highlights this megatrend, as there is a significant and consistent outperformance from the Renewable Energy subsector.  The industry shift impact is highlighted by the drastic measures taken by major energy companies BP, Shell, Total and Repsol to reduce their price assumptions and net zero commitment expectations driving their decisions. 
From the analysis above, it is clear that the Green policy is strongly expected to stay at the top of the investment agenda. Contrary to former concerns that COVID-19 would hinder this process, there has in fact been an acceleration in secular innovation for Electric vehicles, Cleaner fuels and sustainable growth of ESG.
What’s next on the agenda for a green transition?
Although the green issuance started from only US$2.6 billion in 2012, there are many ethical and regulatory considerations which could possibly hinder growth prospects over the coming decade. In order to boost investor confidence in Green bonds on a larger scale, there are two crucial issues that will need to be addressed.
“Green washing” – this is the practice of falsely claiming a green status without adhering to the guidelines published by the International Capital Market Association (ICMA) and the Climate Bonds Standards of the Climate Bonds Initiative (CBI).  These institutions are the most commonly accepted accreditors but for a business to gain ‘green’ certification, the issuer is allowed to pick a certifier of choice; demanding a second opinion. The absence of an international governing body for new investment products has become a red flag in the industry since the Subprime Mortgage Crisis in 2008. Hence, until the independent creditworthiness of green bonds can be verified under stringent conditions, a market boom is unlikely to be seen.
Misaligned objectives – Due to the ambiguity in definition of a green bond, unlike many other financial products, there is little evidence of whether a quantifiable change will be made. Ideally, each stage of the green project from the distribution of net funds to the operational expenses should be reported in advance but this raises costs due to large amounts of empirical data analysis required. Hence, the trade-off between higher transparency costs and ROI may become unfavorable and prevent future investments in green bonds. In addition, the monitoring of finances gained out of issuance is equally as important; an example of a conflict arising from this was Woolworth Group’s AU$400 capital raise through green bond issuance for low-carbon supermarket development. Their proposition was to provide project renovations such as energy-efficient LED lighting within stores but this would also be implemented across their investments in gambling and liquor businesses.  The moral debate of whether it is truly an ESG initiative if it also helps to promote alcohol and gambling proved to discourage investors. This case study is highly relevant because Chief Executive, Sean Kidney stated that under the Paris agreement, 40% of carbon emission reductions must come from improving the built environment. Due to their high demand, renovation project authorization will need high ethical standards and trusted third party governance to gain investment credibility.