Bond Investors Look For Greener Pastures

Wednesday 09 December 2015

The question is of limited interest to philosophers but has a new relevance for investors as debt issuers attempt to shape the nascent market for green bonds — debt instruments aimed at socially-conscious investors who want their money to fund environmentally friendly projects.

This first green bond was issued in 2007 by the European Investment Bank but the product took off in 2013 when French energy company EDF issued the first-ever green corporate bond. The market has grown steadily every year since and reached $70bn this year — the fourth consecutive record year.

Negotiators from nearly 200 countries are currently meeting in Paris in an effort to tackle global warming and curb emissions. Growth in green bonds is unlikely to stop any time soon given the financial commitment necessary to addressing climate change, says Beijia Ma, a strategist with Bank of America Merrill Lynch. “There’s still a gap of $650bn-$860bn of investment that needs to be done every single year between now and 2030, and it is really a question of how we fill that gap and how we get that done.”

Green bonds are split into two categories, “labelled” and “unlabelled”. The unlabelled market is estimated to be far larger at $500bn and encompasses issuers who are pure climate change plays like solar power companies.
In the labelled market, the Climate Bonds Initiative (CBI), a non-governmental agency, runs a certification scheme for the product similar to programmes like Fair Trade or the Rainforest Alliance, which certify that consumer products have met certain ethical standards.

Openly promoting green bonds can be great for public relations, particularly in those industry sectors that are often in the news for wrong reasons. But in private some bankers are concerned definitions have been drawn too broadly.
“For most green bonds they are not new projects; they are old projects wrapped up as green,” says one senior debt banker. “Those projects would have happened anyway.”
Controversial offerings include one from the Massachusetts State College Building Authority that was used to fund a car park among other things while environmental pressure group Friends of the Earth warned that a deal from GDF Suez could fund a hydropower dam that may lead to the extinction of several species of fish and damage the territory of some indigenous tribes.

Proceeds from green bonds need to be earmarked for environmentally-friendly projects. “When the market started out it was development institutions — the European Investment Bank, the World Bank, and so on — they had separate portfolios they could put it in,” says Tess Olsen-Rong, a market analyst with the CBI. “When corporates came into this space, there was the question of how it would work.”

In 2014, an agreement was struck between several of the large investment banks and the industry body ICMA, the international capital markets association, to set out the industry standards. These “green bond principles” are the closest thing the market has to a rule book.
Companies declare for themselves that a project is green, and so alongside the corporate borrowers exists an ecosystem of organisations seeking new business in offering frameworks, certification and monitoring of the companies to solve the inherent principal-agent problems and assure investors that their money is being used as they wish.
“Any issuer could come to the market and claim that his bond is green,” says Michaël Notat, head of global markets at Vigeo. “But the market is already self-regulated, any company that issued a green bond to, for example, fund a coal mine would get very big reputational impact and investors would not invest. There is a very limited risk on this part.”

Independent agencies such as Vigeo and Oekom Research do a similar job to rating agencies for ordinary corporate debt, awarding letter grades to bonds and issuers alike that can reassure investors whether a bond is “dark green, light green or grey scale”.
“Certification is improving as the industry gets bigger. We don’t want to discourage people from investing in green bonds,” says Ashley Hamilton Claxton, corporate governance manager at Royal London Asset Management.
“We do accept standards are lacking among some green bond issuers,” she adds. “It’s up to investors to do their due diligence.”
But the cost of this certification means the only economic benefit issuers get is the chance to diversify their funding — at present green bonds are priced similarly to ordinary bonds and thanks to the cost of guarantees this means they can work out slightly more expensive for first time issuers.
For the moment the market is thus limited to big, repeat issuers seeking to achieve a boost in their public relations rather than being a broader tool for increasing investment in green infrastructure.

Muppet superstar Kermit the frog got it right when he famously sang: “It’s not easy being green.”

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