26: Investor Impact

29 March 2023

In this episode, Ulf Erlandsson, founder and CEO of the Anthropocene Fixed Income Institute, based in Sweden joins Global Sustainability/ESG Partner Anna-Marie Slot to talk about fixed income markets and delivering transition.

Ulf talks about the market shift he has seen around non-climate aligned assets, what he thinks are the most impactful steps investors can take in the next two to three years to help really deliver on the transition to Net Zero and how to get market fired up on delivering climate change.

This is the twenty-sixth episode in our 30 For Net Zero 30 series. In each episode, Ashurst Global Sustainability/ESG Partner Anna-Marie Slot speaks with climate action champions across the globe about real steps to take now towards 2030 goals.

The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Listeners should take legal advice before applying it to specific issues or transactions.



Hello and welcome to our latest episode of 30 for Net Zero 30. I'm Anna-Marie Slot, Global Sustainability and ESG partner here at Ashurst, and we're speaking with 30 change-makers around the globe about actions to take now to deliver on 2030 goals.

Today I'm very pleased to be joined by Ulf Erlandsson, founder and CEO of the Anthropocene Fixed Income Institute, who's based in Sweden. AFFI is a nonprofit organisation dedicated to monitoring and advocating for the use of fixed-income markets for climate-change mitigation.
Thank you so much for joining me today, Ulf. You have a fascinating background in the world of sustainability. Perhaps you could share a little bit more about yourself and how you come to be where you are today.


Yes, thank you for having me, Anna-Marie. Very nice to be here. So my background: I'm an economics PhD from the beginning. I spent a number of years in investment banking, credit derivatives, prior to the great financial crisis, so I have a certain degree of atonement to do, probably. I ran corporate bond portfolios and something called SSA portfolios at AP4, so one was Swedish state-pension funds, for a large number of years, which was really where I started looking into the sustainability dimension of fixed income very early on in terms of the green-bond market.

But that was also a place where I had revelations that it doesn't only matter the good things you buy in a portfolio; it's really the footprint of the bad things that you own in a portfolio that matter a lot. So I've been doing a lot of that thinking over the years, and thinking about how do we both buy the good but also sell the bad, and what is the drivers behind that for fixed-income players. And then a few years back, I got offered to launch this non-profit institute, AFII, which is focusing on leveraging my market-practitioner background and the team's market-practitioner background to inspire other fixed-income investors to tilt and change their capital in a more climate-aligned way.


Interesting. So somebody from the inside who's now come out and started to focus around sustainability. What is that shift? Having been a market participant yourself, what is the biggest shift that you've seen in the last 18 months or so, regarding sustainability in the financial markets?


Well, things are shifting rapidly, I have to say, and thinking 18 months back, we actually had a big action we were doing with AFII, which was with regards to a Russian thermal coal-mining company, which came with an inaugural US dollar benchmark bond, so big bond deal, in September 2021, so just a couple of weeks prior to the COP26 climate meeting. And we were just gobsmacked or flabbergasted, or whatever expression you want to do, very surprised by some very climate-committed parties, it seemed, to bring this deal to the market.

Now, that deal, I think, wouldn't be able to come to market today, not only because it was Russian, but as this thermal coal-mining deal going into broad public markets. End of last year, we looked at another case, a company in Singapore called Sembcorp, who were actually trying to sell themselves some coal assets and get rid of them, but it's almost impossible to get funding for that nowadays. So markets have shifted around to a degree, where certain parts of non climate-aligned assets are not getting access to finance. And especially when it comes to coal and thermal coal-mining, that has shifted. Just in 18 months, it's gone from it was quite possible to do, to almost impossible to do.


Yeah, and that's actually really fascinating. There's a lot of talk and there's a lot of turbulence in the markets around what is happening; what's not happening. Are things moving; are they not moving? But they are moving, actually, and things that were viable two years ago or 18 months ago may no longer be viable as the market participants really do gear up and start paying more attention.

You spend a lot of time really deep-diving in on some of the instruments that are in the market, and in particular focusing, I think, on how investors can approach things or look at different aspects of what's going on in the market. What do you think are the most impactful steps that investors can take in the next two to three years: real game-changers to deliver on this transition?


So I'm going to be... And as a fixed-income guy, I'm used to that. We are always the boring guys. We have very large portfolios. We live on something called carry and roll down, which is getting a little bit, maybe a basis point here, a basis point there, every other day. And we look in awe on our equity colleagues who can make 20%, 15% on a good trade on a good day. We never do that.

But I think that same thinking applies to when I think about how you actually manage fixed income and to be impactful. It is being there the whole time; constantly realigning your portfolios; constantly shifting your capital in your fixed-income book from something which is bad or not great to something which is slightly better. And you continuously keep on doing that, and being tenacious, and having the patience and stamina to actually be applying yourself that way. I think that's the way to drive the big circular transition trend, rather than hoping for the big single action that's going to be there.

Having said that, there is one particular instrument that excites myself and the team and I think is a great way to engage for investors, and that's something called sustainability-linked bonds, where you build in some contractual conditionality into the bond contract, such that the issuer of the bond needs to perform according to some sustainability targets, and if they don't, they get a higher interest rate, or if they do, they might get the lower interest rate. You can play around with that.

I think it's an instrument with a huge potential, and I think that if investors engage with issuers to say, "Let's do this sustainability structure, but let's have an ambitious target and let's have a big differentiation between the interest rate you're going to pay if you succeed versus if you don't succeed," so that you as an issuer, you see a lower cost of capital if you actually succeed with the performance targets there... There are good pricing ways to get around this, option-pricing and so on, and I think there's a lot of stars aligning around that instruments. I really hope that people engage in that sphere. It has had a little bit of a bad rep, but there's plenty of opportunities.


No, exactly, and it's such a young instrument really. You look at the entire commercial, corporate green-bond market. That's only from 2014 when ICMA put out its green-bond principles, right? So that market itself is less than 10 years old. And the sustainability-linked market, which I think really opens up the fixed-income world to all companies who are ready to commit and be honest and have a plan and commit to that plan, is so much younger, even. It's only a couple of years old, but as you say, huge potential there in terms of really driving transition for everyone.


It does have a very good potential of actually lowering the cost of capital on the issuer side, because you can look at it as a traditional bond with an option attached to it, and the size of that option then decides on how big the straight bond coupon should be. So a coal company that might be financing at 6% if they continue to be coal can suddenly access, for example, capital at 4% interest rate if they commit to living up to these targets. And if they don't, then they're going to have to pay a much higher interest rate. And getting that transition going through the SLB structures is quite an exciting opportunity, I think.

So another important thing I think that specifically fixed-income investors can be engaging in is to look across the whole fixed-income value chain, and what I mean by that is a lot of this analysis has come out of the corporate sector, and especially well done from the equity side. Naturally, that's only corporates, and then that has been applied in the fixed-income corporate-bond side, but fixed income is so much more than that. Obviously, you have sovereign bonds, and how do you actually engage and work with sovereign-bond issuers, governments, in terms of climate issues?

We also have this very important middle layer, what I call the super sovereigns and agencies, the SSA sector, which contains the multilateral development banks, the subnational investment banks and such. And as a matter of fact, especially the SSA sector is quite engaged in large infrastructure projects. They have a lot of things to say and finance in terms of both green and fossil investments, and it's a sector that people generally don't know or think about.

We, for example, have written a lot this year about the German development bank KfW, Kreditanstalt für Wiederaufbau, which has been one of the biggest green-bond issuers in the world, but at the same time, they've also been used as a wallet to finance the bailout of Uniper and the completely failed strategy in terms of betting on Russian gas and coal. And how do you engage with an issuer like KfW in order to look at that actually strategy going forward aligns to the target you have as an investor?

I think that's an area which is underdeveloped as it is right now. It's been so much focused on corporates, but think about the whole fixed-income value chain. The additionality here of the fixed-income investor is that if you look at someone like KfW, they're not speaking to any other investors. It's only the lenders, the bond investors, that are engaging with them. So it's an even more crucial role that bond investors have to play there.


No, definitely, and I think that's a fair point, and there's always the question, right? Because fixed income, where it sits in the stack of what people use it for, between equity and fixed income and the different tenures and time periods that people look at in that world, I think, has always been a bit of a challenge: to get fixed-income investors who are looking at a three-year horizon to think about, then, what's the 2030 impact of that or the 2050 impact of that and the credit worthiness of that company?


That's a very good point and that's another thing that... I'm excited by fixed income, obviously, but thinking about the ways you can look at your exposures to climate alignment over time. So it matters if you invest in a two-year bond or a 30-year bond of an issuer, and maybe you should invest more in the short data to see if they actually start achieving targets and say, "We're not providing you with 30-year money, because we're not sure you're aligning the way we want to." So playing the curves on this. And we also see some analysis that we've done very recently that if you look at the long end of the curves 30 years south, now we're talking past 2050, if you are buying a 30-year bond now in an oil company, what's their strategy? Where are they supposed to be at 2053? Well, that's often a hard question for them to respond to or give more detail to, especially those who are non-aligned.


No, exactly, and I think that you're going to see that coming to the market more and more, with all the focus on transition plans and with people having to put actual concrete steps behind net-zero commitments, which are right and good. You need to go out and say your net-zero commitment, but you also need to say, "Okay, what does that look like to me in a three-year? What does that look in a five? What does that look in a seven? What does that look in ten, in order to get where I'm going?" And I think having that information out into the markets will help those fixed-income people.

Because everyone has to refi, right? Even if you're going into a three-year paper, there are very few industries that I've ever come across where you just pay off everything in full at the end.

Everybody's in a refi world.


Yeah. Yeah. No, and again, I think fixed income is much more powerful than people general knowledge. It's definitely one where a lot of the activity is happening in primary markets. So it's actually a transaction is happening between me as an investor, or I'm not an investor but when I was, and the borrowers, i.e., the companies who are receiving the money, that's a straight cash flow there.

And that's different compared to the secondary market argument you have in equities, where it's just you and I. We can trade Exxon shares, but Exxon doesn't really care. And hence, it also matters when fixed-income investors says, "We're not investing in this," because there's no one else to replace them. The issuer then needs to go and say, "Okay, we need to pay a higher interest rate to get other investors involved to fill our books," and that's quite a direct cash bottom-line effect of fixed-income investors' decisions on allocating capital that happens then at the corporate level.


We're now to the point where we always ask everybody, "What about yourself? What is your own commitment?" You're in Sweden, I believe, most of your time at least. So what are you doing in your household?


So we are just about to put in the order for the solar panels on the roof, and that sounds boring, but it starts getting to this self-sufficiency excitement around: if you get the solar panels, then you can charge your car and you can decide when to, and we've got e-bikes which we travel with, and so on. So that's something on that.

Having said that, I travel by bike to work a lot, and city planning is actually something that is engaging me quite a lot, and is probably something that where I might have some extracurricular net-zero activities in terms of getting... Well, we see cities, I see structures out there, built for middle-aged men like myself, but driving big SUVs rather than those who are doing in a better climate-aligned way. So plenty of stuff to influence on the local-policy dimension.


Interesting. Yeah, we've done some interesting conversations around cities and how cities can really become sustainable. So last question: you've been a market participant. You're now really in depth looking at it from that perspective of how to get the markets really firing up and delivering on climate change. In terms of an action or a takeaway for our listeners, what would that be?


Again, as a fixed-income person, you're quite used to large numbers and small numbers, so what's 5 billion times one basis point and so on. Actually, one of the things that led me into think around climate change and now the climate footprint of what we do is actually learning the numbers around the carbon emissions.

So to start out, for example, we generally calculate we have a remaining carbon budget of 300 to 500 gigatons of CO2 emissions. Now, how much is that related to your own personal emissions footprint, which is roughly 10 to 20 tonnes per annum? But more interestingly, perhaps, is that when you see stories and headlines out there and you can start doing these calculations quickly, you start to realise how big things and how big decisions are being made in some places.

For example, there's a story from a few weeks back around BP looking to develop a deep-sea field of Newfoundland and Labrador equivalent to 5 billion barrels of oil. Now, that's such a number, how do you relate to that? Well, if you learn the mathematics around this, then you can quickly say that, okay, one barrel of oil is roughly 0.4 tonnes of CO2, hence 5 billion barrels is equivalent to 2 billion tonnes or two gigatons of CO2 emissions, and then you can relate that two gigatons of CO2 emissions to the 500 gigatons we have of the remaining carbon budget. And then you realise: oh, this is a big decision. This is something that is really relating to this budget that we have.

So getting a grasp of those numbers, because it's very easy to make it anonymous and not care if you don't have hold of that, but just sit down and try to figure out the difference between the megatons, the gigatons, the annual emissions, the remaining budgets and so on. I find that very compelling. I try to teach that in some of the courses I do as well.


Yeah, so helping perspective, I think: providing perspective people in the conversation and talking about how we make these changes. That's been fantastic. Thank you so much, Ulf, for joining us. Thank you for sharing your insights with us today.


Thank you very much. Thanks for having me.


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