When investors go green

Some $216bn worth of green bonds have been issued so far this year, according to the Climate Bonds Initiative. That compares with around $168bn in 2018. And since the run-up to year-end tends to be busy, total global issuance for this year is predicted to handsomely overshoot the 2018 figure.

But how significant are these numbers? And do green bonds live up to their hype?

Let’s start with a reality check on the size of the phenomenon. Green bonds, while frequently claiming newspaper column inches, make up less than one percent of the overall bond market (estimated to be around USD100 trillion). In terms of volume, green bonds are still small fry in a very big pond.

But there’s no doubt there is solid interest. So, what’s the draw? In my experience, there are several benefits of green bonds, for issuers and investors alike.

Win-win

Investors buy green bonds because they want to be part of the transition to a greener and more climate-resilient future. As well as for ethical reasons, they do it because they believe that, in the long run, ‘green’ assets will be less risky than ‘brown’ ones.

The funds raised are dedicated to environmental purposes with the Green Bond Principles as the most widely used reference for what qualifies as ‘green’. Pension funds and other asset managers increasingly face mandates for investing ‘responsibly’ and green bonds are a welcome outlet for this mandate.

There are benefits to the company issuing the bond as well: in addition to diversifying their investor base, it is common to hear bond issuers testify to the educational process they go through when preparing to issue a green bond: companies often talk about how they have benefitted internally through the creation of greater environmental awareness and cooperation across business segments.

Teething Problems?

But since they first appeared on the scene some ten years ago (the World Bank was the first issuer), green bonds have faced their fair share of criticism. It has been argued that they represent ‘greenwash’ and that they don’t offer anything new beyond what standard (‘vanilla’) bonds do. To some extent, the critics are right. At times the green bond label has been applied with less than ideal levels of scrutiny. This recent report, for example, describes how a green bond issued in Brazil in 2017 has financed fairly standard tree plantations geared more towards commercial ends rather than reforestation.

But let’s remind ourselves of one key point. Bonds are essentially debt instruments, like loans – they don’t pretend to be anything else. Their primary focus is to raise money – not necessarily to offer breakthroughs on how to finance environmental projects.

Rather than criticising green bonds, I would argue the underlying problem is misperceptions about what green bonds are and what they are designed to do. Most green bonds are issued by corporates (or governments) with good credit ratings who are simply wishing to finance, or refinance, their assets. Expressing social and environmental intentions is part of their motivation, but it may or may not be the primary driver.

Rather than expecting green bonds to be a panacea, we can take a different view: we can see green bonds as part of a bigger movement where investors are seeking purpose and positive impacts as well as returns. If we take this approach, the discussion becomes more meaningful (and less frustrating).

A green movement

What could this broader movement be made up of? For businesses looking to increase their purpose, green bonds are just one of a range of options. Natural capital accounting, for example, enables companies to list their assets and liabilities in the natural world in the same way they have traditionally listed other (produced) assets and liabilities. Accounting for impacts and dependencies will not automatically change corporate behaviour – but it can be part of a process that builds a ‘conscious culture’ within a business. The old adage of ‘if you can’t measure it, you can’t manage it’ should give businesses motivation, while The Natural Capital Coalition provides them with protocols for how to do it.

Other options, such as discounted green loans, directly target firms’ incentive structures. The French electricity giant Electricité de France just announced a revolving credit facility which offers discounts for reaching green Key Performance Indicators. In other words, your loan will be cheaper if you can prove that you are improving your environmental performance.

People-driven

Green bonds, natural capital accounting and discounted green loans are all part of a shift towards more purposeful business – the flipside of which is purposeful investing. Anecdotal evidence shows this trend is clear (I have recently been offered to switch my pension to a fully ‘sustainable portfolio’, and I know I am not alone). And data backs this up: according to the Global Sustainable Investing Alliance, the market for sustainable investments grew 34% between 2017 and 2018.

Private enterprises respond to needs in the market, be that in what they sell or in how much ‘purpose’ they have. The driving force behind purposeful business is thus in large part purposeful investors – and they will determine the pace and direction of developments. Investors are already voting with their feet by divesting from CO2-intensive sectors and investing in green ones.

The future may see us looking back at the emergence of green bonds and conclude that this was the start of a trend: the beginning of a process when the public at large - not just businesses - began acting with purpose.

[This blog first appeared as a guest blog for the International Institute of Environment and Development (IIED): https://www.iied.org/when-investors-go-green]

Pernille Holtedahl19 November 2019