What’s in a name? The problem with green bonds
Green bonds are on a roll.
The global market for green issuance has grown from $10 billion in 2013 to over $40 billion in 2015 and could reach an annual value of over $200 billion in 2017.
There are several different types of green bonds – including use-of-proceeds bonds, revenue bonds, project bonds and securitized bonds – but the common thread is that these securities raise capital for specific goals dedicated to climate or environmental projects.
Supranationals have led the charge. The first green bond was issued in 2007 by the European Investment Bank. Named the Climate Awareness Bond, its proceeds were dedicated to renewable energy and energy efficiency projects. The World Bank followed up with its first green bond in 2008, a SEK 2.3 billion 6-year issue sold into Scandinavian pension funds. In 2012, the first corporate green bonds were issued and the rest is history.
The impressive growth of the market is a product of two trends.
Firstly, governments the world over are stepping up the fight against global warming. Issuance accelerated following the Paris climate agreement in December 2015. In fact, it nearly doubled, from $41 billion in 2015 to $92 billion in 2016. Unsurprisingly, China is fast emerging as a leading issuer of green bonds, exploding onto the scene with $36 billion of issuance in 2016 and accounting for nearly half the entire green bonds market.
Equally important are the efforts of issuers to diversify their own funding regimes, reaching new investors with innovative products. In recent years the green market has started to mature and diversify, with an ever-growing cast of issuers and structures – green covered bonds, green residential mortgage-backed security (RMBS) and green Schuldschein, to name some recent milestones.
Interesting things are happing on the demand side, too, as investors get increasingly creative in sourcing new green opportunities. IFC recently announced that it’s partnering with Amundi to launch a new green bond fund supporting environmentally friendly projects in developing markets. They aim to raise a $2 billion war chest, creating the world’s largest emerging markets green bond fund. This initiative should be praised for addressing the needs of developing countries who struggle to deal with the effects of climate change on economic and social life.
But there are major obstacles holding back development of the market. Concerns abound regarding “greenwashing”, whereby unsuitable projects are financed through green bonds. At present, issuance standards are voluntary and there is no monitoring to ensure compliance with market frameworks. We are seeing a trend toward fragmentation, with the likes of China developing bespoke standards.
The market is crying out for harmonization and the adoption of universal standards to foster investor confidence. But this might not actually be possible, since projects differ so widely in purpose. The problem is one of semantics – “green bonds” is a catchall term that lumps heterogeneous issuance together under one brand, failing to capture the diversity and complexity of the market and its participants.
Another challenge is liquidity. Around $203 billion in green bonds have been issued since 2007 but this is small fry compared to global bond issuance and investor demand far outstrips supply. Oversubscription and tight pricing are the norm in primary, and the secondary market is thin.
The rise of sovereign issuance should go some way to address this, with governments seeking to implement Nationally Determined Contributions (NDCs), for which sovereign green bonds are a logical financing option. In December 2016 Poland issued its debut green sovereign bond and in January 2017, France followed up with a huge €7 billion issue. But it will take time for supply to match demand and bring liquidity to the market.
2017 looks set to be a landmark year as the G20 begins to prioritize action on climate change and China continues to step up issuance. Expect increased issuance, harmonization and product diversification in the years ahead.
Although a decade has passed since the first green bond was issued and despite the explosive growth of the past few years, it’s still early days for the market. Issuers, investors and dealers have been highly innovative and collaborative in their approach to this new asset class, but much work remains to be done.
After all, all good things take time.