Article 5 / 6

Delivering income
Hunt for IncomeOct 4 2017

Green bonds are crying out for global standards

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
Green bonds are crying out for global standards

Over the past few years, the popularity of green bonds has soared as a way of channelling money towards climate-friendly purposes. In June, Apple raised $1bn (£745m) in a bond dedicated to financing clean energy and environmental projects. The offering came just over a year after the company issued its first green bond of $1.5bn (£1.2bn) – the largest issued by a US corporation, as a response to the 2015 Paris climate change agreement.

A green bond offers a financial return through the payment of its coupon like any other bond, but with one key difference: the money raised is exclusively assigned to finance projects and business activities labelled as green. Examples include, but are not limited to:

•    Renewable energy

•    Energy efficiency

•    Sustainable transportation

•    Low-carbon projects

•    Sustainable water management

There is still a primary focus on achieving the maximum financial return, but this consideration is balanced by environmental objectives. 

Green bonds generally have a medium-term maturity of five to 10 years, are given credit ratings like other bonds and are issued in multiple currencies and from many issuer jurisdictions.

At the end of June this year, the total market value of green bonds stood at $118bn (£88bn). Although this represents a fraction of the overall £100trn bond market, demand is growing and the market is expected to double in size again this year, according to Moody’s. The climate-aligned bond universe is valued at $694bn (£517bn), six times the size of the green bond-only universe.

When did they first emerge?

The labelling of green bonds is a relatively recent activity; the first green bond was issued by the World Bank in 2008, in collaboration with SEB, the leading Nordic Bank and Scandinavian Pension Funds. This followed on from the release, the previous year, of a Climate Awareness Bond by the European Investment Bank, which was the first to introduce the concept of tying revenues to climate investment.

Corporate involvement gradually became more pronounced until, in 2016, the number of green bonds issued by the corporate market outstripped those issued by international organisations like the World Bank. 

China overtook the US to be the largest issuer of green bonds last year, a third of bond issuance growth was driven by the country. China needs at least $300bn of green investment per annum over the next five years to help counteract environmental damage caused by the country’s rapid industrial growth.

Key points

  • A green bond offers a financial return through the payment of its coupon.
  • Investors are increasingly identifying projects related to the shift to a lower carbon economy. 
  • US President Trump’s rejection of the Paris Agreement popularised green investment 

The 2015 Paris Agreement saw 150 nations agree to limit the global temperature increase to 2 degrees celsius, signalling a step change in the way governments are addressing climate change. 

Recognising the opportunity, forward-thinking investors are increasingly identifying projects related to the shift to a lower carbon economy. Growth sectors such as renewable energy need financing.

By 2020, the UK needs to generate 15 per cent of its energy from wind, wave, solar and other renewable sources.

We are also seeing an increase in environmental awareness, particularly among the millennial generation, which has resulted in investors becoming more interested in how and where their money is invested. 

Subsequently, we have seen demand for environmental, social, and governance (ESG) factors to be included in the investment process by fixed-income investors, which is something that can be fulfilled by green bonds.

What effect has the US withdrawal from the Paris Agreement had?

US President Donald Trump’s rejection of this agreement caused a significant backlash and, inadvertently, popularised green investment as a counter-action to his rejection of climate change.

The International Energy Agency estimates that $93trn (£69trn) of energy investments are needed between now and 2035 to follow the 2 degrees path. Governments and supranationals will be unable to provide all the capital and capital markets will therefore have to fill in the shortfall with investments, such as green bonds.

When is a green bond not a green bond?

While demand looks set to rise even faster in the months and years ahead, it has not all been plain sailing.

One problem has been a proliferation of definitions, each claiming to accurately describe the characteristics of a green bond. For example, the commonly accepted definition of a green bond in China requires only 50 per cent of the revenue from a green bond to be used for green projects, compared to a general international rule which expects 95 per cent of revenue to contribute. Had this been adhered to in China, one-third of green bonds issued in 2016 would have had the label rejected. 

Widely accepted industry standards are needed to address the growing risk of greenwashing, damaging trust and actual efforts to finance environmental projects.

How are these challenges being met?

In response, multiple efforts have been made to develop commonly accepted standards for green bonds to ensure a level-playing field. These include:

1.    The Green Bond Principles (GBP)

First published in 2014, the GBP are seen as the most developed framework. They state that green bonds should be assessed through four core components: the use of the proceeds, which should lead to clear environmental impacts; transparency detailing how the bond is eligible to be described as ‘green’; tracking and careful management of the proceeds; and reporting on the use of the proceeds.

2.    The Climate Bonds Initiative (CBI)

Like the Green Bond Principles, these standards agree that the use of funds and revenue must be tied to green projects. However, it also provides a framework which sets out the eligibility criteria, by sector, for green projects, thereby lending itself more readily to immediate applications.

3.    Moody’s Green Bond Assessment (GBA)

The ratings agency Moody’s has developed a public methodology for the assessment of green bonds. It has the potential to be a useful tool for investors, allowing the credible ranking of issuers in a granular system.

In the absence of a global standard, the majority of issuers commission external reviews of their green bond investment frameworks for the benefit of investors.

Several companies, such as Deloitte, Vigeo and Cicero have responded to this need. Cicero is the leading provider of second opinions and through its rating system, assigns each bond a ‘shade’ of green – the darker the green, the greener the bond.

Of course, the costs associated with obtaining this independent verification are easier for some to shoulder than others.

Where next?

As with any new product, a few teething problems are to be expected. Despite this, the outlook for green bonds looks positive.

The majority of mainstream index providers have added green indices to their library, a sign of the market’s growing maturity. These include the Bloomberg Barclays MSCI Green Bond Index and the Standard & Poor’s Green Bond index, which both set clear guidelines on what constitutes a green bond.

There has also been a move towards impact reporting by green bond insurers on the bonds’ use of proceeds. Quantifying the climate or environmental impact is critical to helping investors measure the positive outcome of their investments.

Is 2017 the year for sovereign green bonds?

Undoubtedly, significant investment opportunities will arise as countries strive to meet their emission reduction targets under the Paris Agreement. 

Poland was the first country to issue a £750m green bond, followed by France who kicked-off 2017 with a record-breaking €7bn (£6.15bn) green issuance. There has only been two sovereign green bonds issuance to date. With other countries, including the UK to follow, the predicted 2017 green bond issuance of $150bn looks well on the way to being achieved.

Over the last 12 months, we have seen the launch of a number of green bond funds in Europe. Our preference is the Allianz Green Bond fund, managed by an experienced team that ensures selected investments have a high impact on the environment while not being detrimental to society. 

Damien Lardoux is portfolio manager at EQ Investors