The colour of money

IFR Review of the Year 2014
8 min read
Alex Chambers

They may not quite be all the rage just yet, but Green bonds are an increasingly popular funding option for borrowers keen to do, or at least be seen to do, the right thing. They’re great PR and (usually) good finance. But do they actually help to make the world more green?

Some US$40bn in climate change projects were funded with Green bonds in 2014 – a four-fold increase from the previous year and, according to some estimates, just a fraction of what lies ahead in 2015. Stakeholders are increasingly demanding socially responsible investments, helping to turn the Green bond sector into a force to be reckoned with.

Starting from 2008 when the World Bank funded environmental projects through what are now seen as proto-Green bonds, the product has evolved to finance a range of well-intentioned projects, from clean water and energy efficiency to better use of land and even sustainable waste management.

But many market participants say that, despite the worthiness of the cause, the nascent asset class is riddled with difficulties. Yields can be low, regulatory hurdles can be high – and there are serious questions about whether the deals are fulfilling the objective of helping the environment.

The expansion of the Green bond market into the corporate space – from what had largely been the domain of multilateral institutions and development agencies – has even led to allegations of “greenwashing”, in which the Green bond label is applied in order to give a false depiction of a deal’s environmental worthiness.

“Unlike pure debt instruments, Green bonds aren’t only a funding vehicle – they’re a communication vehicle,” said Jonathan Weinberger, head of capital markets engineering at Societe Generale.

And this public relations aspect – the portrayal of an issuer’s apparent earth-friendly ethos or politics – can appear to be more important than the actual value to the environment produced by any given trade.

“There’s a real debate going on here,” said Stephanie Sfakianos, head of sustainable capital markets at BNP Paribas.

“If you are a pure-play green company, why can’t you be just a green issuer?” she said. “Why do you need to be a Green bond issuer?”

Of course, there is another PR aspect of Green bonds that can be viewed cynically, or accepted at face value: the possibility for the financing industry to show its social value.

“Here lies a big opportunity for us involved in the finance industry,” said Frank Czichowski, treasurer at KfW, who believes that Green bonds offer the industry a chance to mend its rather battered reputation with the general public.

“The more we can demonstrate and communicate that we can provide solutions to the challenges of society and the world at large, the more we can repair the rift,” he said.

Measuring stick

The financing of renewable energy and of energy efficiency ventures are the most frequently stated uses of proceeds from Green bonds, though it is often far from clear that a bond so designated is actually contributing to fight climate change.

Indeed, this remains an unregulated area lacking transparency, common standards and clear definitions. Not surprisingly, many debt syndicate bankers are thus privately dismissive of the concept, and will describe deals as dark, medium or light green, in accordance with how environmentally friendly they believe them to be.

In tandem with the rise of Green bonds, however, efforts are growing to try to evaluate the merits of those instruments. Previously, debt investors with strict SRI mandates had little way to gauge whether any given deal was actually green.

But the Climate Bond Initiative, a non-profit organisation that aims to mobilise the bond markets to work on climate change, has promulgated the Climate Bonds Standard, a screening tool to help determine if any given security is contributing to that goal.

In addition, a consortium of investment banks came out a year ago with the Green Bond Principles, a set of voluntary guidelines for the development and issuance of Green bonds.

Issuers are urged to clearly explain the use of proceeds so that buyers can be sure a deal is consistent with their mandates or investment strategy.

“The Green Bond Principles provide a framework,” said Susan Barron, managing director in frequent borrower debt origination at Barclays. “It is voluntary, but it provides for a set of best practices to which issuers, investors and lead managers can refer.”

And there are the so-called second opinions provided by various rating companies that issuers of Green bonds solicit in order to persuade investors that their deals are as advertised.

“There are moves afoot for second opinions to use a standardised format, that is clear and concise to lay out what really is green,” said Sfakianos at BNP Paribas. “Let’s have quantitative analysis rather than just fluff.”

That appears to be happening as the push for standards spreads to the index space. The Barclays MSCI Green Bond index family was launched in November.

“The criteria are more defined than any other index, and some deals don’t make the cut,” said Laura Nishikawa, head of fixed income ESG research at MSCI. “That’s what people are looking for.”

Adds Weinberger at Societe Generale: “We are starting to see restrictions on use of proceeds and a greater consensus on what is a Green bond.”

That standardisation looks increasingly important given the expansion of corporate green issuance. There are five securities that failed to satisfy the criteria of the index so far.

Yet for the moment, such efforts appear to be largely moot. The guideline principles, for example, do not create an authority or any single gatekeeper – leaving no obvious way to guarantee the integrity of the Green bond market.

And at present, most of the billions invested in Green bonds do not provide fresh financing for carbon reduction or other green causes. Put plainly, most of the projects backing Green bonds would have gone ahead anyway.

More to come?

The 2014 report from the Climate Bond Initiative calculates that there are already more than US$500bn of bonds outstanding that are climate-related, most of which were not labelled as Green bonds.

Fiona Reynolds, managing director at the Principles for Responsible Investment – a network of institutional investors with US$45trn of assets under management – believes the market will continue to grow as investor appetite increases.

One head of US debt capital markets said that bond originators at his bank were being pushed hard to source new deals from the corporate sector, though many companies felt that the hurdles they had to jump through were, for the moment, too great.

“One of the areas in which we will continue to see development is impact reporting,” said Barron at Barclays.

“Issuers such as the World Bank, IFC and EIB have already published a significant amount of data and update the information regularly. Newer issuers to this market are still working to find the best way and frequency to report on what they’ve done with the bond proceeds.”

KfW’s Czichowski believes that investors should be prepared to accept a lower yield in the asset class, arguing that the price mechanism provides the clearest signal to the market – and that all should contribute to the goal of environmental protection.

Many in the market agree.

“I don’t see how there’s a way back,” said Sfakianos. “When you call investors, no one puts the phone down when you talk about this topic. Sustainability is too important now.”

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The colour of money