Green bond issuances by automakers have been muted so far for three reasons: additional compliance requirements, abundant liquidity in the money markets, and a low-interest-rate environment. However, the terrain is set to change with regulations around green debt making compliance cost non-discretionary. Additionally, the imminent widening of interest rate spreads will make margins attractive and the economics of issuance favourable.

Regulatory mandates aligning with the Paris Agreement are also becoming par for the course. The European Union (EU) is aiming to produce 30 million^I EVs by 2030, in its bid to steer away from fossil fuel-based transportation. With EU regulations mandating 37.5% reduction in CO₂ emissions from 2030 - relative to the 2021 baseline of 95g/km - automobile makers are aggressively pursuing transition to EVs from internal combustion engines.

In 2020, the increase in EV registrations in the EU more than doubled on-year to 1.4 million, representing ~10% of overall volume. This was nearly half of the 3 million increase in EV registrations worldwide, of which China accounted for 1.2 million and the US 0.3 million. With this, the EV base in Europe increased to 3.2 million, compared with 1.8 million at the end of 2019, taking it closer to China, which has the largest EV fleet globally at 4.5 million^II.

The upshot? Growth in EV investments would speed past those for internal combustion engines, and account for more than half of the capex by global automakers over the next five years. We foresee green debt driving a larger proportion of these investments. 

Regulations have forced automakers to set aggressive electrification targets

Much of the EU’s net-zero objective is dependent on the transportation sector’s green transition since it accounts for ~30% of all greenhouse gas (GHG) emissions. EU legislations have pushed automakers to invest in EVs and drive away from internal combustion engines by 2035. Consequently, automakers have had to draw up investment roadmaps for much of this decade. The bulk of these investments will be for capex, and research and development for future technologies, especially electric and hybrid powertrains.

All that will translate into billions of dollars of investments by the turn of the next decade. A boom in green finance would be the subscript of this epochal transition saga.

Green debt issuances by the sector, however, are sparse

Even though regulatory impetus and aggressive EV transition growth plans augur well for a green finance wave, a deeper dive reveals that green debt issuance has not taken off. Till now, only a handful of green bonds have been issued in Europe (€4.5 billion by EU automakers^III). Abundant liquidity with European credit institutions (€3.8 trillion as of November 2, 2021 vs €1.7 trillion at end of 2019) and a low-interest-rate environment - both consequences of the pandemic - are the likely causes of the modest delta (60bps^IV) between green and regular debt financing and explains the fewer issuances of the former by automakers. More compliance requirements and higher issuance cost relative to vanilla bonds have also been hurdles.

Looking ahead through the rest of the decade, green finance off-take remains imminent to support the sector’s pace of transition and possibly looming regulatory fines

There is a turn in the road now. Automakers have to transition towards EVs to avoid regulatory fines. The 2014 EU regulations on fleet-wide CO₂ standards had mandated automakers to reduce CO₂ emissions to 95g/km by 2020 for passenger cars (and freight vehicles weighing less than 3.5 tonne). Because this was a stiff target, the EU allowed a one-year phase-in and sought 100% compliance starting 2021. But most automakers have missed this milestone.

With finance norms to support green technology set to become more stringent - CO₂ emissions of less than 50g/km^V as per EU Clean Vehicles Directive (for passenger and freight vehicles weighing less than 3.5 tonne) until 2025 and only zero-emission vehicles from 2026 (implying hybrids will lose their ‘green label’) - automakers are charting plans to increase capex and R&D spend for electrification (spent about $40 billion^VI in 2020). That, and the giant strides the European lending and investing community is taking towards net-zero commitment mean a surge in green finance offtake is imminent. 

To be sure, OEMs have reduced CO₂ emissions, but the levels are still above the prescribed range. They need to reduce further to access green debt. With banks and debt-market investors having to align with the EU’s Fit for 55 climate package, green issuances would take off in the next 12-24 months. The economics will also be beneficial as demand will outweigh supply, and regulatory mandates will result in compliance cost becoming non-discretionary for issuers.

^I Source: Bloomberg
^II Source: IEA – Global EV Outlook 2021
^III €2bn issuance by Volkswagen AG, €1bn each by Daimler AG and Porsche AG, and €0.5bn by Volvo Car AB
^IV Difference between average green debt coupon vs. overall average for coupon rate of bonds issued during the relevant year
^V Applies for battery electric vehicles, fuel-cell electric vehicles using hydrogen, and plug-in hybrid electric vehicles
^VI Source: Estimated spending based on equal annual investment over companies’ stated invested periods