Sovereign ESG Financing: Italy’s First Green Bond Gets Warm Reception, Helping Ease Funding Risk

Last week’s debut green bond of the Italian Treasury – a EUR 8.5bn note maturing in April 2045 – came shortly after finalisation of Italy’s framework for the issuance of sovereign green debt, aligned with ICMA Green Bond Principles and the EU’s Sustainable Finance Taxonomy. The government has outlined categories of public expenditure eligible for green funding, as well as the tracking and reporting procedures to ensure proceeds are allocated appropriately.

Improving Italy’s debt profile and funding flexibility

The long maturity of this issue supports the extension of the average maturity of Italian government debt, which stood at seven years last December – around the median for advanced economies. Any hypothetical extension over time of this average maturity of public debt would be considered credit positive for Italy’s BBB+/Negative ratings from Scope, given the significant relevance of spacing out redemptions in view of Italy’s significant debt load.

Debt-maturity extension supported by the green bond framework is set to be maintained as the government expects to top up this long-dated 2045 bond.

In addition, the issuance diversifies Italy’s investor pool – not only in respect to longer-term groups of investors but also with an increasing body of environmental, social and governance (ESG) investors. As foreign investors purchased 74% of this debut green bond – this expands the investor pool as well by geography, though we recognise that a core historical credit strength of the Italian sovereign has been a strong domestic investor base – with foreign investors more prone to capital flight in periods of risk-off sentiment.

The fact that the issue received over EUR 80bn in demand is important for the government’s funding flexibility amid the recent sharp increase in global sovereign yields – and as the ECB contemplates longer term an eventual exit strategy from presently elevated net asset purchases.

Better programming of green government expenditure

The establishment of the sovereign green bond framework signals Italian authorities’ commitment to addressing climate change and environmental risk and could support better programming of green government expenditure. Reporting requirements with respect to the use of proceeds, together with heightened market scrutiny, support better environmental policies.

We see Italian authorities maintaining a fiscal stance supportive of gradual economic recovery in the coming years – including investment in combating climate change. However, associated excess deficits as the Covid-19 crisis wanes, together with a still challenging longer-term growth outlook, leave concerns hanging over the longer-term trajectory of public debt, with debt-to-GDP likely exceeding 160% by if not before the next global or regional crisis.

Low borrowing rates vital for Italian debt sustainability

In this context, it is critical that low borrowing rates anchor Italian debt sustainability. Locking in a 1.5% coupon for this period of above 20 years with the green bond helps reduce stepwise Italy’s vulnerability to bouts of capital-market volatility particularly if interest rates increase.

Italian yields reached historic lows over recent weeks, of under 0.5% for the 10-year bond, and trades at time of writing around 0.75% – nonetheless highly accommodative.

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Giacomo Barisone is Managing Director of Sovereign and Public Sector ratings at Scope Ratings GmbH. Dennis Shen, Director, and Giulia Branz, Associate Analyst, contributed to writing this commentary.