Green bonds have had a strong start to 2018 and there seems little in the way of further expansion. Here is a brief primer on the market.
What are Green Bonds?
Green bonds were created to fund projects that have positive environmental and/or climate benefits. Most are green “use of proceeds” or asset-linked bonds. Proceeds from these are ‘earmarked’ for green projects and backed by the issuer’s entire balance sheet.
How does the green bond market compare with other markets globally?
The green bond market kicked off in 2007 with the AAA-rated issuance from the European Investment Bank and the World Bank, but bonds investors really took notice in March 2013 when a US$1 billion green bond issued by the IFC sold within an hour. That November the first corporate green bond was issued by Vasakronan, a Swedish property company. A green muni bond was issued by Massachusetts in June 2013 and Gothenburg issued the first Green City bond in October 2013.
The market is now growing almost exponentially, although it is still small compared with the sovereign and corporate bond markets. By 2020 it is expected to top US$1 trillion. Last year (2017) alone there was $157 billion in new issuance. Issuers come from both developed and emerging markets. January saw Norway, Malaysia, Singapore and Hong Kong come to market. February brought Sovereign green bonds from Poland, closing its second issue, and Belgium. Other early offers this year have included France’s green OAT issue, with Italy and Sweden likely to follow.
Why is the market growing so fast?
Everyone – the financial sector, regulators, investors and the wider public, like the idea of money being put to ‘social good’. Debt-laden governments cannot afford to finance the increasingly urgent transition to less-polluting ‘clean energy’ and diversified energy security themselves. They need the private sector to get involved. After the global financial crisis, the biggest banks especially have welcomed an opportunity to repair their reputations and demonstrate how they contribute to an ecologically sustainable future. End investors, particularly those with a social mandate like pension funds, want both the returns offered by the opportunities of green investments, and the lower ESG risk they represent.
Who decides whether a bond is ‘Green’?
This is an important credibility and trust issue for the green bonds market. Initially there was a loose definition where issuers simply had to ‘aim to’ contribute to improving the environment. With this self-regulating ethos, some issues had very tentative connections to that goal. Now there is far greater scrutiny by organisations such as the Climate Bonds Initiative and guidelines from the International Capital Market Association. More stringent and verifiable definitions of what constitutes ‘green’ ensure the market overall retains its reputation. The ‘green’ label comes from what the finance is used for, not who issues the bond. Some companies considered high polluters have issued green bonds, while other with strong green credentials have stayed out of the market because of additional transaction costs, including tracking, monitoring and reporting on use of proceeds.
Who are the issuers? What is the demand?
National and local governments, cities, supra-national organisations and corporates are now all issuing Green bonds. In 2016, corporates accounted for 58% of all issuance. The biggest issuers now are banks, particularly in China. Bank underwriters have made green bonds a growing part of their business, partly as a useful way to cross-sell other services. Companies may issue ‘green bonds’ to burnish their brand with their stakeholders – Apple being a recent example. Successful sector and regional Benchmark issues have reinforced investor confidence.
Source: Climate Bonds Initiative
Are Green bonds available in all sectors?
Green bonds are primarily associated with the financing of the transition to clean energy, but they are available in sectors like real estate, infrastructure and even manufacturing. ‘Blue’ bonds, aimed at financing the protection of the Ocean or marine economy, are under consideration. What about the impact of the US withdrawing from the COP21 Climate Change agreement? In December 2015, 195 nations agreed to tackle climate change at the landmark COP21 Paris conference. It was a major deal because of the urgent need to reduce global CO2 emissions. However, in June 2017 the US government withdrew, saying it was negative for the US economy. Many feared other signatories would follow. But none did, and remaining states declared themselves more determined than ever to address climate issues. Additionally, many policy decisions devolved from governments to cities keen to future-proof their infrastructure, so the COP21 Agreement survives.
What is the next step for the green bond market?
It is likely to continue to grow with widespread support from policymakers, regulators, issuers and investors. There are some structural issues to address, but market proponents are well aware of the need to maintain credibility and trust. In some jurisdictions, the possibility of fiscal incentives for issuers has been raised as a way of further incentivising all involved. That may highlight sensitive questions of regulatory or market arbitrage, but overall the market is likely to continue to deepen and broaden, with inevitable new layers of complexity as new ‘green’ structures are offered.