The green bond market continues to grow

Although still relatively niche, the rate of issuance of ‘green bonds’ has accelerated sharply this year. Adam Carruthers looks at the market that aims to fund a cleaner, greener world.

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  1. Adam Carruthers

Investment-grade bonds financing environmental projects are known as green bonds. Proceeds raised from their issue go towards projects focussed on climate mitigation or adaptation efforts.

According to their supporters, green bonds are one of the best fixed-income instruments to contribute to the energy transition to renewables and de-carbonisation. Importantly, they provide the possibility of tracking the use of proceeds and measuring their environmental impacts.

The European Investment Bank pioneered the market by issuing the world’s first Climate Awareness Bond in 2007. Whilst the UK government has yet to issue a green Gilt, countries such as France, Belgium and the Netherlands already have.

The green bonds universe is still a relatively niche market, despite its strong growth and evolving sector diversification. The market has grown significantly since 2013 and is now worth about £300bn as of 30 June 2019. Indeed, issuance this year has already exceeded £150bn.

Europe focussed

Geographically, the green bond universe is currently biased towards European issuers and denominated in Euros. This relative lack of US-dollar issuance (many USD corporate issuers do not pass the “greenness” test) has been a drawback from an asset allocation perspective, leading to underweight USD credit compared to broad global bond indices like Bloomberg Barclays Global Aggregate.

Importantly, there is no current legislation or standard classification of green bonds. To standardise what qualifies, the International Capital Markets Association has established voluntary guidelines. The Green Bond Principles provide a framework for issuers, but they don’t represent certification. That’s where the Climate Bonds Initiative (CBI) comes in.

The CBI is an investor focussed, not-for-profit organisation dedicated to promoting investments for a low-carbon and climate-resilient economy. As part of its remit, the CBI issues certifications and accreditations to green bonds. To be approved, bonds must comply with the Climate Bonds Standard framework. This framework is fully aligned with the Green Bonds Principles but goes a bit further. It specifies a detailed taxonomy of eligible projects and assets, plus rigorous pre- and post-issuance requirements. Importantly, the EU is creating a Green Bond Standard, which will build on these current market practices.

There are three main indices that investors can compare their green bond selection against. The ICE Bank of America Merrill Lynch Green Bond index, which includes issues by corporate and government & quasi-governments but does not integrate any selection filter with regards to the green bonds it includes. This contrasts with the Bloomberg Barclays MSCI Green Bond index which employs a filtering approach based on six MSCI-defined eligible environmental project categories. The third main index, Solactive Green Bond, is tracked by the Lyxor Green Bond ETF.

Due diligence needed

It is still important for those selecting individual green bonds issued by companies to conduct thorough credit research on the underlying strength of the issuers and their ability to pay coupons and return the principal. Risk awareness is very important because green bonds bear the same risks as conventional bonds.

There has been a recent backlash against so-called “greenwashing” in the booming green bond market, where some issuers have been accused of a misalignment between a green issuance and the environmental strategy of the issuer.

For example, following the June 2018 government change, Ontario’s government decided to end their programme to reduce GHG emissions. Abandoning it, in addition to a new position on climate change, completely changed the issuer’s ESG quality and the alignment of green bonds projects with the new overall strategy.

Critics point out that green bonds share flaws seen in many financial innovations: complex, expensive and not very effective. Worse, the current hype risks damaging the broader green finance effort. Green bonds are not designed for funding the riskier new investment needed to transform the economy.

Steve Waygood, head of responsible investment at Aviva Investors, pointed out that green bond issues represented only 0.1% of all outstanding bonds and were largely used to refinance existing projects. The biggest green gripe is that it allows companies and investors to simply tick the green box rather than move to more effective strategies at tackling climate change.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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