With the UK Green Finance Taskforce recommending the issuing of a sovereign green bond and the recent launch of the Green Bond Pledge, now is the time to get to grips with the rapidly expanding green bond market. What’s so special about them and do they really make a difference?
What Makes a Bond Green?
Green bonds are debt securities which channel proceeds towards environmental projects. Their financial mechanism mirrors that of regular bonds; bondholders can expect coupon payments and the return of the principal come maturity. For the market, green bonds represent a financial instrument which complements the increasingly widely held belief that investors and financial institutions have a duty to promote sustainability where possible. In this sense the emergence of a market for green bonds is largely an investor induced phenomenon; environmentally friendly projects have been and continue to be financed by regular bond issuance; the “green” label may only serve to highlight certain bonds to investors who count sustainability amongst important investment criteria.
It’s been mentioned that green bonds finance environmental projects, but this definition is extremely broad. As it stands, there is no binding regulation or definition which green bond issuers must adhere to; the Climate Bond Initiative certifies green bonds which meet scientific criteria, ensuring that projects being financed are consistent with the Paris Climate Agreements. Having said this, the certification process requires much progression before it can be an effective signal for investors; criteria for bonds financing projects in recycling, hydropower and tidal energy are still under development, whilst the development of criteria for bonds financing projects in the industrial sector is yet to commence. Of the $24.2bn worth of green bonds issued in 2018, only $0.7bn are fully certified and $11.6bn are not aligned with the CBI’s criteria at all. The alarming lack of a framework for this rapidly growing market forces investors to engage in much due diligence, perhaps creating a further transaction cost for investors seeking to generate returns from sustainable practices.
Do They Make a Difference?
A key selling point of green bonds is that by and large, they offer similar yields and spreads to regular bonds, meaning that investors don’t have to sacrifice value for sustainability. This, however, begs the question of how impactful green bonds really are? Green bond issuance in 2018 is expected to reach $250bn, almost double the value of green bonds issued in 2017, but does this represent a near doubling of environmentally friendly projects being undertaken? Whilst it is true that in several sectors it is increasingly worth investing in sustainability, now more than ever it is hard to determine how many bonds are being issued under the green umbrella when they would have previously been issued normally. If yields and spreads are in line with the rest of the bond market, it would suggest that the projects being financed were already deemed worth investing in irrespective of their environmental impact. Rather paradoxically then it is not the mass of investment grade green bonds which make a sizeable impact in preventing climate change and environmental degradation; the reality is that these projects are likely worth financing anyway. If investors want to truly go above and beyond the existing market allocation of capital to green activities then they ought to seek smaller and riskier green bonds being issued.
Undoubtedly the sentiment that finance ought to be more a force for good is gaining traction amongst investors and financial institutions, but ultimately the green bond phenomenon is not living up to the hype. By differentiating supposed “green bonds” from the wider bond market despite similar financial profiles, financial institutions are simply using cheap marketing tricks to convince themselves and investors that some sizeable impact is taking place on the back of a staggering increase in green bond issuance. Whilst certification is somewhat of an issue, for the green bond market to have a meaningful impact on climate change going forward it is up to investors to cough up a premium for genuinely tackling climate change above and beyond existing market activities. If the UK government and other sovereignties heed the advice of green finance groups then, they ought to ask whether any bonds they issue are really green enough?
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