Global issuance of so-called green bonds is increasing considerably, with the market attracting a greater range of issuers from governments and quasi-sovereign institutions, to municipalities and private firms.
Green bonds are structured much like any other government or corporate bond with defined coupons and maturities. However, issuers are required to use the proceeds of the bonds to fund ‘green’ projects, such as renewable energy technology or clean transport infrastructure. Investors are promised stable long-term returns – along with the reputational boost that investing in green bonds can provide, which is becoming increasingly important to clients.
A range of issuers now tap the green bond market. For example, in February the New York Metropolitan Transportation Authority issued $500m (£404m), targeting institutional investors and citizens keen to contribute to a project to upgrade the city’s public transport system. Large multinational corporations such as Apple, Toyota and Unilever are also getting in on the act.
It’s easy to see the motivation for governments, cities and companies to issue green bonds – they get to raise capital and burnish their environmental credentials. But what’s in it for investors?
On average, green bonds price at similar levels to non-green (or plain vanilla) bonds of similar maturities from the same issuer. This means that fund managers can use the green bonds to satisfy investment mandates without settling for lower returns. Moreover, green bonds have proved to be robust despite their relative novelty. Demand has remained strong during periods of volatility, suggesting these bonds are aligned with a long-term trend for green investing that will outlive short-term peaks and troughs.
While the growth of the green bond market is welcome, more must be done to ensure that these products deliver on the environmental benefits they promise. There are no standardised criteria governing how green bonds should be defined or how the impact of the projects they help fund should be assessed.
As the market grows in size it is becoming increasingly difficult to gauge the environmental worth of green bonds. Much of the market consists of refinancing for existing infrastructure, rather than capital-raising for new projects, calling into question the additional benefits derived from the bond issuance.
In an attempt to bring more rigour to the market, the International Capital Markets Association (ICMA) has set out the green bond principles, a set of guidelines that recommends issuers take steps to demonstrate the environmental benefits their bonds will deliver.
Specifically, the principles call for issuers to be transparent in four areas: how they will use the proceeds; how they will select the projects that will receive financing; how they will manage the proceeds; and how they will report on the ongoing environmental impact.
Meanwhile, the Climate Bonds Initiative, a not-for-profit organisation looking to promote investment in green projects, offers certification for bonds intended to raise capital for climate-related schemes.
However, compliance with these standards is entirely voluntary, and some issuers ignore them altogether, choosing to ‘self-certify’ green bonds without disclosing how they determine their own green criteria or detailing the projects they will finance. As a result, investors are left in the dark as to whether the bond truly makes a difference to the environment. The risk here is that an issuer will make erroneous claims as to its green credentials.