More than a decade ago, the World Bank’s offered the first green bond and a blueprint for what is currently a $500+ billion market (watch a video on the history here). In fact, green bonds set a new annual high in 2018, according to global law firm Linklaters, with more than $140 billion issued globally. This is 31% higher than issued in 2017. However, some say these environmentally friendly bonds come with challenges that may affect future growth.
So, what are green bonds exactly? This type of bond secures funds for new and existing projects with an environmental conscious. This includes projects that mitigate climate change impacts — such as renewable solar and wind farms — or other projects relating to energy efficiency, habitat restoration, or clean water for example.
Green bonds provide investors with a way to earn tax-exempt income on sustainable or environmentally friendly projects. Typically, issuers of the bonds also stand to benefit by attracting new, ethically-driven investors.
This may sound great to environmentalists or renewable advocates but these bonds also present challenges. Here are three that currently stand out.
1. Muddy waters
The specifics of what aptly constitutes a green investment have been fairly open to interpretation. This means what qualifies as green to one investor may be in the black (or let’s say, muddy) for another, leading to uncertainty in the market.
As Amrita Ahluwalia, Capital Markets lawyer at Linklaters, summed up in a press statement: “Alongside increased activity, we are seeing increased debate around what constitutes a green bond, with various shades of green emerging. Investors want to ensure they are committed to projects that will make an environmental difference, so we may see the evolution of green bond markets as a result of active regulatory involvement.”
Indeed, the ambiguity around what qualifies as “green” may prevent the type of investment from realizing its true potential.
Ahluwalia predicted regulatory involvement and that’s currently what the green bond market lacks. Essentially, the market has developed on a self-regulatory and voluntary basis without legalized standards.
Fortunately, there are sets of voluntary green bond principles that provide guidelines to help clarify the issuance of such bonds.
For example, International Capital Market Association (ICMA) offers process guidelines in its The Green Bond Principles (updated in June 2018). ICMA says it is committed to building trust in the market by promoting internationally accepted standards of best practice and engaging with international and national regulators and policymakers.
Climate Bonds Initiative, an international and investor-focused not-profit, is another example of an organization that’s working to provide providing policy models and advice. It is also developing a standard. According to its website: “The Climate Bonds Standard and Certification Scheme is a FairTrade-like labeling scheme for bonds. It is designed as an easy-to-use tool for investors and governments that assists them in prioritizing investments that truly contribute to addressing climate change. The Standard is a public good resource for the market.”
Climate Bonds Initiative also provides the Wind Criteria evidence-based criteria for which wind-power projects and assets are eligible for certification under the Climate Bonds Standard and Certification Scheme.
Although these regulations are voluntary, they are certainly a step in the right direction if the green bond sector is to grow and thrive.
3. A purpose
For the most part, green bonds are much like other bonds. Green bonds are typically priced like others of similar structure, duration, credit rating, and issuer. So, what is the point?
Of course, green bonds provide investors with an opportunity to financially back important projects relating to the environment or climate change. But without set standards or regulations, it’s somewhat unclear whether a separate type of bond is necessary for this purpose. Technically, a regular bond could also work and without so much uncertainty or ambiguity.
Nevertheless, investing in “green” typically looks good for one’s portfolio. And, more importantly, it is good for the environment. What’s more: despite the uncertainty of the sector, the global issuance of green bonds is forecast to grow by 20% in the year ahead, topping U.S.$200 billion, according to a new report from Moody’s Investors Service.
The rating agency says it sees a number of factors boosting the green bond market, including:
- Strong investor demand
- A growing emphasis on sustainability
- An increase in repeat green bond issuers
- A growing harmonization of global green bond standards
It seems green bonds are here to stay, which is likely a good thing for renewables. Advocates say they may provide wind and solar projects with the competitive advantage they need over the fossil fuels industry, potentially reducing risk and capital costs.