Green bonds are so common it’s time for some quality control.
Green bonds, the oldest and best-known component of ethical finance, are booming—as is the broader market that finances environmental projects and climate change mitigation. But not all such bonds are created equal. For investors, identifying corporate and sovereign bonds that truly meet objectives for specific environmental impacts is an increasingly complex task.
According to the Climate Bonds Initiative, cumulative issuance of green bonds since 2007 is nearing $1.5 trillion; and the sector continues to grow rapidly, with $297 billion issued in 2020 and $500 billion forecast for the full year of 2021. The stellar growth in ESG finance has spawned an ecosystem that includes issuers, underwriters, index providers and investment managers.
The proliferation of new issues has increased pressure for a definitive set of standards to aid in evaluating impacts and to limit the opportunities for “greenwashing”: marketing-driven initiatives with little to no environmental impact. These are the standards corporate issuers will soon have to meet.
And today the net is cast beyond environmental issues to encompass social and governance concerns that drive investors to take a harder look at an issuer’s integrity. In the case of government bonds, for example, what is the issuer’s human rights record? Debt capital markets will be closely watching the Philippines as it gets ready for its first-ever sovereign green bond—while the International Criminal Court investigates the country’s deadly war on drugs.
Public relations benefits asides, green bonds attract premium pricing, resulting in lower interest costs over conventional bonds. The “greenium” equals savings of one to 10 basis points globally for the borrowers, according to ING.
Standards? What Standards?
The most actively referenced standards include the Climate Bonds Initiative, the International Capital Market Association’s Green Bond Principles and the UN Principles for Responsible Investment.
Yet there is a narrow gap between altruism and profits in fast-growing markets, says William Mock, portfolio manager for fixed income green bonds at Shelton Capital Management. “Absent a definitive set of standards, investors have turned to measuring what environmental impact a specific bond will have,” Mock says. “There is a multitude of data providers evaluating impact or ‘greenness’ of both individual bond issues and the portfolios of ‘green’ products offered by investment management companies.”
Still, Mock believes the market will evolve to fill the vacuum: “Over the next decade, an oligarchy of trusted, green, quality benchmark providers will differentiate themselves as clear leaders for reference purposes.”
Until then, investors can play a role shaping green finance. “There is an argument that not all green bonds are equal. [But] if we base our investments on only those organizations that meet current benchmarks, our impact will be minimal,” Gunjan Sinha, founder and executive chair of MetricStream. “If we drive responsible growth within companies that lack an ESG strategy, we can fundamentally change the world. I predict that balancing the desirable and the undesirable will be the playbook of the future.”
Enter fossil fuel companies. They were quick to embrace Net Zero—not adding new emissions—and though emissions may continue, offsetting those by absorbing an equal amount from the atmosphere. But investors remain suspicious over the conflict of interest between fossil fuel companies’ core business and how they deploy funds raised through green bonds.
“How do you compare a bond issued by a fossil fuel producer or utility with one in say the REIT sector?” Peter Krull, founder, CEO and director of investments at Earth Equity Advisors says that for his company the answer is clear. “We would rather invest in the REIT bond knowing that it is being used for energy efficiency, water and clean energy upgrades. Who knows what the fossil fuel company will do with the proceeds?”
Despite that, the world’s largest oil exporter, Saudi Arabia is reportedly preparing its first-ever green bond, throwing down the gauntlet to sustainable investors in a first-of-its-kind moment. Saudi Arabia’s reputation for debt suggests the bond(s) will be large enough for investors to come running, and that could trigger similar issuance from other national oil companies.
The jury is still out as to whether companies provide enough information to satisfy investors on corporate issues. But there is a growing consensus in areas such as low-carbon transition benchmarking that qualifications for green bonds will soon be formalized, providing clarity to bankers and CFOs.
Governments Step Up
Meanwhile, governments are also rising to the challenge. Although there is no uniform standard in the European Union, the voluntary European Green Bond Standard adopted in July of last year is designed to provide guidance to investors and issuers globally on what activities align with the EU Taxonomy for sustainable activities. The EU describes the framework as a new “gold standard” for green bonds, which can be benchmarked by other countries.
In October, the European Commission issued its first-ever NextGenerationEU green bond, raising a total of €12 billion (about $13.6 billion). More than 11 times oversubscribed, the final order book exceeded €135 billion in what has been billed as the world’s largest green bond offering to date. The NextGenerationEU green bond framework contains nine categories, including energy efficiency, clean energy and climate change adaptation. Up to €250 billion in similar bonds are expected to be issued by the end of 2026.
China has been a prolific issuer of green bonds, but analysts say a large percentage do not meet international standards. There are indications the situation is improving. In April, the National Development and Reform Commission and China Securities Regulatory Commission launched the new Green Bond Endorsed Projects Catalogue with the People’s Bank of China, the central bank. It gives investors a wider view on acceptable green projects in the country, but analysts say gaps remain and the disparity between national and international norms is likely to persist
Is climate change driving the market? Governments continue to be criticized for their inertia on these issues, and widespread reaction to the release of the UN’s Intergovernmental Panel on Climate Change report in August has been highly critical. There is no escaping that fossil fuels will be around for quite some time. In 2020, the latest complete year of data, 83% of the world’s energy consumption was derived from fossil fuels, according to BP’s Statistical Review of World Energy 2021. Even if all nations fulfill current climate promises, the International Energy Agency estimates fossil fuel use will still constitute 73% by 2040. But Earth Equity Advisors’ Krull says that despite mixed signals and government indecision, investors will increasingly pressure companies to improve corporate citizenship.
“COP26 was a big disappointment,” says Krull. “Politicians are seeing the writing on the wall regarding the existential threat of climate change but continue to kick the can down the road. I don’t believe that it will have a positive or negative effect on attitudes towards green bonds. That market is going to continue to grow as investors demand new issues and corporate action.”
Fossil fuel companies may cut a lot of sway, but they will have to bow to the influence of what the Climate Bonds Initiative estimates could soon become a $1 trillion green bond market annually by the end of 2022. They appear to already acknowledge the rise of impact investing and are encouraging investment and public-private partnerships in sustainability related projects.
For all the discussion about standards and whether data providers can temporarily fill the vacuum, there is still much work to be done. A November report by The International Organization of Securities Commissions says that ESG ratings are falling short. “There is little clarity and alignment on definitions” and “a lack of transparency about the methodologies underpinning these ratings or data products.”
Meanwhile, banks and financial firms are still lending at a frenetic rate to carbon intensive industries. Ratings agency Moody’s estimates that across G-20 countries, financial firms hold $21 trillion in loans and investments.