Imagine lending money to a company to invest in green projects, and that group then using the proceeds to pay off other debt. That money has no discernible environmental impact and there is nothing you can do: it is all in the contract.
Investors face this risk today. The green bond market is growing faster than ever, and companies and governments have borrowed more than US$100 billion so far this year.
This financing is needed if the world is to move toward a low-carbon economy. However, a lack of agreed standards, patchy reporting and weak commitments raise significant questions for those seeking to invest for more than just financial return.
Only a third of green bonds issued in the past three years met our three-stage criteria for sustainable issuance. This leads us to question the “green bond” label and, more generally, it could undermine the authenticity of dedicated green bond funds.
Our analysis has red-flagged more than a dozen green bonds in 2019 alone, meaning that we will not add them to sustainability-focused mandates.
There are many examples of green bonds with significant weaknesses. Real estate is responsible for nearly 40 per cent of global carbon emissions, according to the International Energy Agency. Green investment could help reduce this but green bonds from several property companies have failed to meet our minimum criteria, with weak detail on how bond proceeds will be used and the expected energy saving. In some cases, the proceeds may cover payments for other bonds with no green characteristics — meaning the green bond proceeds would lead to no carbon reduction.
US utilities have issued green bonds with the potential to fund power purchase agreements. This would in effect subsidise renewable energy for consumers by purchasing such energy from other providers, rather than directly contribute to the generation of more renewable energy. Utilities in Europe, on the other hand, use green bond proceeds to build wind and solar farms: a more tangible result.
Across all sectors, inadequate reporting is a concern. Reports that detail how proceeds are actually used are a luxury, when that should be a minimum requirement. Without clear, comparable metrics, it is difficult to assess the impact of green bond holdings. Fortunately, plenty of excellent reporting exists. A positive development has been issuance from alternative sectors. Telecommunications companies have issued green debt this year. However, even though most proceeds are expected to be used for energy efficiency, such as upgrading copper cabling with carbon fibre, the money has to be spent anyway. It is important for the investor to assess the incremental benefits to the environment relative to the expenditure.
Sovereign green issuance is generally better. The green bond issued recently by the Netherlands had a clear framework with ambitious commitments on renewable energy, energy efficiency and water management. Another example is Poland, which issued its third green bond in 2019. That issuance highlights a particular problem: some issuers are offering green bonds targeting specific projects but without a clear, long-term strategic environmental goal. While the proceeds of Poland’s green bond are allocated in positive ways, the country overall continues to rely heavily on coal and bond proceeds are not being used to address this dependence.
The gold standard for green issuance is a bond that also contributes to a wide, long-term sustainability strategy.
We are still a long way from this, which is why recent developments — such as the European Commission’s green bonds standard and the UK’s green finance strategy — are critical for the development and credibility of the market by raising the standards for green bond issuance. They will bring transparency and clarity and lead to further growth.
It also explains why some asset managers have set out to assess the sustainability credentials of green and social bonds. Investors in sustainability-focused strategies expect their portfolio managers to think independently and analyse portfolios against their objectives, just as they would for financial characteristics.
Even if new green bond standards are widely accepted, the unique characteristics of green issuance and their role within an issuer’s wider strategy mean such analysis will have to play a greater role. Otherwise, the temptation will remain to issue bonds that are green in name only. Issuers need to step up their approach but asset managers also bear a responsibility to ensure that the green bond portfolios they present to clients are truly green.
Joshua Kendall is a senior ESG analyst at Insight Investment
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