Being truly "green," sustainable, or aligned to net-zero goals, is complicated. It’s definitely not as simple as buying something with a virtuous label.
What are green bonds?In a bold initiative, the European Investment Bank issued the first "green bonds" in 2007. Since then, the appetite for such bonds has soared: $3.5 billion worth were issued in 2010 and by 2020, the value of new green bonds issued was $305.3 billion.
These bonds are designed to direct capital towards projects with a positive environmental impact. This money is supposed to be used to mitigate the causes of climate change and build a greener future. As the Climate Bond Initiative puts it: “The green bonds era has begun — mobilizing bond markets as a low-cost financing tool will be essential for the realization of a low-carbon and climate-resilient economy.”
Certainly, green bonds have had some positive environmental effect. However, relying solely on these instruments to solve the world’s environmental problems is wishful thinking.
There aren’t enoughThe data reveals that not all sectors — and certainly not all the relevant sectors — are issuing enough green bonds. For example, the energy sector’s operations cause 9% of all human-made greenhouse-gas emissions. The fuel it produces creates another 33% of global emissions. According to the International Energy Agency, to achieve a 1.5 degree Paris-agreed pathway, we should develop no new oil or gas fields. Given this, the energy sector should surely be using green financing? In 2020, the sector issued $1.2 billion in green bonds, but raised $214.7 billion in traditional bonds. This means less than 1% of the total debt raised was "green." This year’s figures are similar.
Lack of oversightCurrently, there’s not enough oversight to measure the differences green bonds make. A bond can be called "green" even if it doesn’t require a company to reduce emissions. Yes, there is impact reporting, which may require the company to disclose a project’s emissions. However, this doesn’t necessarily translate into any company-wide commitments to reduce emissions.
In the property sector, companies are permitted to use refinancing debt to purchase green buildings built a decade ago. In reality, no one builds or develops any new properties.
In the automobile sector, cars only have to emit less than 50g of CO2 per kilometer to be considered sustainable under new EU regulations, and only until 2026. And manufactures sell plug-in hybrids as a low-carbon alternative to traditional vehicles. Policymakers consider these vehicles eligible for green bond status. However, recent research suggests hybrid vehicle can emit 2.5 times more CO2 than official tests indicate.
The risk of companies "greenwashing" is also considerable, especially in emerging markets. According to the Climate Bonds Initiative, almost 8% of the green bonds issued in 2020, worth $8.8 billion, did not meet green labeling standards.
The only way to uncover how sustainable or green a bond could be is to do the research.
Doing the homeworkThe only way to uncover how sustainable or green a bond could be is to do the research. Scrutinizing the use of proceeds, the impact reporting and the alignment with recognized standards is important. The issuer’s overall ESG credentials are also crucial. For example, in our view, a utility company that doesn’t have coal phase-out plans issuing a green bond to finance renewable projects raises serious questions. This said, there are many good green bonds out there for investors and asset managers willing to put in the time to do their due diligence.
We previously highlighted some of the automobile sector’s shortcomings. However, as with any industry, some companies are doing better than others. Automobile companies that have ambitious goals for hybrid and electric vehicle sales, or extremely detailed disclosures about its exclusion criteria, for example, may set a high bar for other automakers looking to issue green bonds.
At the country level, we have Chile. Here, the government is enacting aggressive decarbonization policies and carbon budgets to support a net-zero economy by 2050. In 2019, Chile was the first Latin American country to issue a green bond that directs proceeds towards climate resilience projects. These include flood-defense infrastructure, efficient irrigation systems and upgrade to water-waste management — all essential in addressing the physical risks of climate change.