The explosive growth of the ‘green’ bond market might remind observers of the T-shirts worn by trendy toddlers in North London sporting the logo ‘Green is the new Black’. Over the past three years, the market has grown by slightly more than a factor of 10, from $3.1 billion to $36.9 billion.
As well as the supranational issuers that led the market, such as the World Bank, 18 countries have seen issuance in that time, and the issuers include supranationals, corporates and municipal authorities. “It’s lovely, isn’t it? And this is just the beginning,” says Christopher Flensborg, head of sustainable products at SEB, which worked with the World Bank issuing the first green bonds.
Given that insurance company Zurich has recently awarded a $2 billion green bond mandate to BlackRock, a figure that would have swamped the market just two years ago, this seems convincing.
Green bonds can be issued by any entity that would normally raise money on the capital markets. Although the money raised must be used for projects or investment with a positive environmental impact, they are backed by the issuer with full recourse, just like its mainstream bonds.
Because the credit risk is the same, the pricing is usually the same, as there is no extra risk. More and more investors are seeing the benefit of buying investments that have the same return profile as the usual instruments but promise returns to a wider range of stakeholders, which may well include those investors in other capacities.
The research SEB did initially led them to talk to the big reinsurance companies, who are very much aware of their exposure to climate stress, from extreme weather events to drought or regular flooding. “We became aware that as asset owners, we were also exposed to those risks,” says Flensborg.
Manuel Lewin, head of responsible investment at Zurich, has a similar take. “We are a very global company. When we think about our customers and other stakeholders, they are directly exposed to the global risks of climate change.”
Green bonds seemed like a good fit for the insurance company on two levels, he says. “There are two aspects: how do they help us to achieve a certain objective and the second element is the structure.” As an insurance company, fixed income makes up the vast majority of its assets, so green bonds were ideal from that standpoint.
Zurich has put in place an official framework for responsible investing, which it sees as putting money to work in a way that may produce value for a broader range of stakeholders. Green bonds fit neatly into this framework, explains Lewin.
Categories of impact
The principle of impact investing as conceptualised by Zurich is three-dimensional, he says. The first is intentionality — the positive impact is not just a side effect (otherwise any successful investment that was not actively harmful could count). Zurich focuses on two categories of impact — the environment and what they call “community capital”, largely about making communities more resilient.
The intended impact must be measurable in some way: “If you make something part of the investment objective, you’ve got to see if you’ve achieved it,” says Lewin. “We want to see at least some attempt to measure it in place.”
And the investment must be profitable. “This is not investing a foundation’s money, it’s balance sheet money that we are talking about.”
Green bonds in their current form ticks all these boxes neatly. But that form is not set in stone. In fact, no aspect of green bonds is set in stone, which may be at the same time one of the biggest drivers of market growth and possibly one of the risks to the overall market.
“Nobody has taken ownership of green bonds,” says Flensborg. “It has not been a closed club.”
Although the World Bank and the other supranational issuers are working together to build standards for green bonds, other issuers are neither obliged, nor in many cases able, to follow their lead. The World Bank, for example, is able to talk to potential investors about their commitment to the concept before allowing them to put money in, ensuring a committed and reliable investor base.
Although many issuers would presumably love to be in such a position, it would not be realistic for most. Equally, they may not be comfortable with the levels of transparency a body like the World Bank can offer on the projects invested in.
There is also no agreement on what counts as green for these purposes. In each case, it is up to the investor to look at the prospectus and decide whether they are comfortable with the proposals.
As Lewin says: “Green is not black and white. Even among climate scientists there is no agreement.” An obvious example is that in France, nuclear power is seen as a clean, carbon-free energy source, while in Germany it is seen as too risky and damaging to be counted as environmentally friendly.
So far, attempts to produce standards for green bonds have focused on ensuring transparency, and even there, it is in early stages.
There are three levels where transparency is relevant: the governance that oversees how funds raised by green bonds are allocated; the actual project; and what the environmental benefits of the projects have been in actuality.
“In the market, around the first level, we’re in a good spot,” says Lewin. “That is where certification is helpful.”
Confident
On the second two levels, he says hopefully progress is being made.
The expansion of the green bond market has been explosive, but can it continue? Sean Kidney of the Climate Bonds Initiative is convinced it will, and even that it will accelerate when governments get on board.
“We’re pretty confident of seeing $50 billion of issuance this year,” says Kidney. “We could easily see $100 billion.”
The Climate Bonds Initiative is an NGO that aims to facilitate the market by helping develop certification standards, building a database of all green bonds issued and promoting the conversation around them.
According to its records, the “green muni market is exploding” as cash-strapped subnational authorities realise they can raise money and improve their reputations at the same time. Corporate bond issuers are finding it a useful way to raise money too, particularly in certain sectors.
Property companies have found it easy to take on board the concept, “because it’s broadly accepted within the sector that green buildings are easier to rent and cheaper to maintain”, according to Christopher Flensborg of SEB.
Money raised will be used to build environmentally optimised buildings. Waste management is another sector that could see green bonds as a useful tool. When the market hits $100 billion (which might happen this year if there is significant Chinese issuance), Kidney expects governments to start taking an interest.
“It will make an impression on governments about how they can manage the transition [to a low carbon economy] by financing it with green bonds rather than taxpayers’ money.”