Green bonds need not be niche but are often misunderstood

Thursday 10 October 2019

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Monica Filkova, Head of Market Intelligence at Climate Bonds Initiative expands on green bonds; what they are, where they came from and how they have evolved over time to become a strong force in the industry.

The beauty of the green label is that it can be applied to any financial instrument that funds an asset with a climate benefit. Green bonds are treated as niche by some, but market evidence shows that at least for larger deals (USD300m or more), denominated in EUR or USD, half are being bought by investors with green bond funds and ESG mandates, and half by mainstream investors. So, while greenness may be a factor for some, fundamental credit metrics obviously meet the requirements of others.


There have been green senior unsecured bonds, hybrids, sukuk, agency mortgage backed securities, private placements, Schuldschein, covered bonds, loans, deposit schemes and so on. All are like their vanilla counterparts, except they finance green assets and projects. With the increased focus by regulators on climate risk management, banks and investors are ramping up efforts to identify the underlying composition of their portfolios. And Increasing exposures to green loans and green bonds to address overall risk.


Historically, investors have looked at companies’ business models and policy to determine if they meet their ESG requirements. Green bonds move the focus from the company to the assets being financed. Two key requirements of the label are to identify the use of proceeds and to select assets and projects that will deliver a climate benefit.


Consequently, green bonds are universally suitable – as much for “green” companies that operate in climate-friendly sectors such as solar or wind power generation, public transport and electric vehicles, as for “brown” companies such as oil & gas majors embarking on a greening of their asset portfolio and business model … and every other company or public sector in between.


Some oil & gas, utility and electricity grid companies have used green bonds to fund the beginning of their transition to a greener asset portfolio, i.e. investments in renewable energy and connecting renewable energy facilities to country grids. There have been criticisms that such issuers use green bonds for PR purposes. However, the fact that many are repeat green bond issuers points to a changing strategy. Green bond labelling has been instrumental in drawing attention to individual actions by companies and governments, and the global momentum in funding the transition to a low carbon economy.


2007 saw the first green bond issued by the European Investment Bank, with the World Bank entering the market in 2008. Multilateral development banks (MDBs) have continued to play a key role in promoting green finance, particularly for infrastructure investments in emerging markets, but it was the entrance of local governments from France, Sweden and the US and corporates (Sweden) in 2012-2013 that saw green bonds gaining traction. The global market now comprises 750 issuers from 55 countries according to the latest Climate Bonds Initiative (CBI) data.


The public sector has funded a variety of assets with a strong focus on large-scale infrastructure, such as rail networks, public transport, sustainable water and wastewater management, and a variety of public buildings. Multifamily housing in the US is being upgraded to be more energy and water efficient with the help of green bond funding. The private sector has raised funds for renewable energy, low-carbon buildings, EV infrastructure, certified forestry and so on.


In 2015, green bond issuance was just under USD45bn. The Paris Agreement, which sets to limit global warming to 2C, was signed at the end of that year. In 2016, issuance doubled. In 2018, it topped USD170bn, according to CBI data. The market passed the USD100bn mark in late June this year: the first time this has happened in the first half of the year. In 2017, this was achieved in early December, in 2018 in mid-September. This bodes well for continued growth.


But it’s not just about volume. The launch of the ICMA Green Bond Principles (GBPs), has helped establish due process and facilitated disclosure. GBPs ask for clear definitions of eligible funding categories, transparency in asset selection, dedicated management of proceeds and post-issuance reporting on allocations. The GBPs now form the basis for a variety of policy standards and guidelines. This includes stock exchanges with green and sustainability bond segments: there are now about 20 such listing venues around the world.


According CBI, about 90% of issuance now benefits from external reviews that confirm compliance with the Green Bond Principles. Around two thirds of issuance through November 2017 benefits from post-issuance reporting on allocations, and about half of issuers report both allocations and environmental impact metrics. This level of disclosure is unusual in the fixed income space, except for secured debt and structured finance, and provides investor assurance. Widespread adoption of Taskforce for Climate-related Financial Disclosure (TCFD) recommendations is likely to further boost reporting best practice.


A commonly cited obstacle to green bond market growth and product adoption is the lack of definitions of what is green. What sort of metrics would an asset need to achieve so it is compliant with the Paris Agreement or a scenario where global warming was to be kept under 2°C?


CBI has used the Climate Bonds Taxonomy since 2013 (with updates), and the European Commission has just released the first part of the EU Taxonomy. China has adopted a comprehensive green bond catalogues for its financial and corporate issuers. it’s not that there are no definitions, rather that the definitions are evolving and there is scope for further harmonisation.


While a lot of green bond issuance to-date has focused on climate-change mitigation, adaptation and resilience (e.g. flood defences, storm protection, etc.) as well as social factors now playing an increasing role in financing strategy and investment decision making. If transport, water, waste and public building infrastructure is not climate-resilient, it may well fail to deliver the social value when increasingly severe storm, flood or drought strikes.


Fundamentally, green bonds are a bridge to achieving Nations Sustainable Development Goals (SDGs) which are being adopted by companies, investors and governments to measure progress across environmental and social improvement needs. If transport, water, waste and public building infrastructure is not climate-resilient, it may well fail to deliver the social value when the next storm, flood or drought strikes.


in tandem with the growth of the labelled green bond market, there has also been a rise in the issuance of sustainability, SDG, ESG and social bonds, and loans. Some see this as fragmentation of an already small market. However, it can provide clarity if labelling becomes more consistent and coalesces around key terms to denote focus on the E in ESG, the S in ESG or the whole of ESG.


Green bonds are not the be-all, end-all of sustainable finance, or even green finance, but they have helped elevate climate financing from a niche discussion to a part of global action.



Interested in learning more about the CFA UK Certificate in ESG Investing? Find out more and register your interest here.

This article was written by Monica Filkova,Head of Market Intelligence at Climate Bonds Initiative (CBI). If you too would like to join the conversation and share your views on the development of ESG investing and its impact on our industry, please contact to enquire about editorial opportunities.

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