Growth of green bonds poses challenges for investors, regulators

Foreign Policy Centre research associate Stephen Minas outlines the green bond dilemma, where a broad definition of green bonds risks greenwashing and a more rigorous definition comes at the expense of scale.

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Green bonds are issued with an explicitly environmental purposes, including renewable energy, energy efficiency, and sustainable forestry. Image: SUWIT NGAOKAEW /

The launch of a green bond index by British bank Barclays and index provider MSCI is the latest attempt to set standards for the rapidly growing green bond market. The creation of bonds with an explicitly environmental purpose has presented new challenges for both market participants and regulators. As green bond issuers and buyers quickly organise their own standards, the question confronting regulators is whether, and how, to step in.

From a market of just $3 billion in 2012, Bloomberg New Energy Finance has predicted that issuance of green bonds will increase from $14 billion in 2013 to $37 billion this year. The World Bank Group began issuing green bonds in 2008 and was soon joined by other development banks. Much of the growth of the last two years has come from private sector issuers. Cities are also getting in on the act.

Market analysts expect further growth to come from Asia. Last year, the Export-Import Bank of Korea issued a $500 million green bond, which the bank has stated it will use to finance ‘low carbon and climate resilient growth’ projects. The Chinese government has committed to developing a corporate green bond market.

There is no universally accepted definition of what makes a green bond. The World Bank’s selection criteria for eligible projects includes renewable energy, energy efficiency, sustainable forestry and other categories. Green bonds are aptly described by Bloomberg New Energy Finance chief editor Angus McCrone as ‘an umbrella term that encompasses several different types of security’.

Like most new markets, buyers and sellers haven’t waited for regulation before beginning to trade. Instead, influential market participants have developed their own voluntary standards. In January 2014 a group of multinational banks released the ‘Green Bond Principles’, described as a set of voluntary guidelines for the issuing of green bonds.

Membership of the Green Bond Principles had grown to include seventy firms and financial institutions. The World Bank and other development banks are members alongside commercial and investment banks. The Principles cover use and management of proceeds, processes for project evaluation and selection, and reporting. The Principles will be updated in 2015 following industry consultations.

Voluntary industry standards such as the Principles are a familiar feature of transnational markets. At this early stage of the market’s development, the Green Bond Principles are just one of a number of private standards being applied or in development. The Climate Bonds Initiative, a non-profit backed by large financial institutions, has developed its own prototype standard for climate bonds.

In the case of green bonds, the obvious question is how effective private standards will be in securing outcomes consistent with the environmental aspirations they embody.

This self-regulation has parallels in other markets of environmental significance. In the forestry industry, for example, the Forest Stewardship Council and the Program for the Endorsement of Forest Certification continue to offer competing standards. In the case of green bonds, the obvious question is how effective private standards will be in securing outcomes consistent with the environmental aspirations they embody.

For the development banks which originally issued them, green bonds were in part a response to the reality that public financing for climate mitigation will continue to fall far short of the additional $36 trillion between 2012 and 2050 which the International Energy Agency says is required. For the institutional investors subscribing to them in growing numbers, green bonds are in part a hoped-for ‘safe’, long-term investment, and in part an instrument for offsetting losses on ‘stranded assets’ (assets that stand to lose much or all of their market value under ambitious climate policies).

There is already huge market demand, with many bonds oversubscribed and some selling out within minutes of being issued. Nevertheless, the quick growth of the market has left multiple questions for issuers, subscribers and regulators to contend with.

The chief investment officer of Zurich Insurance, which has committed to significant investments in green bonds and subscribes to the Green Bond Principles, recently warned that ‘if there is going to be a lot of “green washing”, this market will die’. As the OECD has noted, the trade-off is between a broad definition of green bonds which risks ‘green washing’ and a more rigorous definition which comes at the expense of scale.

Concerns about ‘green washing’ could grow if mainstream investors increase as a proportion of subscribers. The Climate Bonds Initiative estimated 2013 demand for green bonds from subscribers with a ‘sustainability mandate’ at between 58 per cent and 80 per cent, meaning that mainstream investors already made up a significant portion of the market. Non-specialist investors could find themselves poorly placed to assess how ‘green’ a bond is, especially if confronted with competing voluntary standards.

A further issue is that ‘some green bonds are greener than others’. As McCrone suggests, confidence in the green bond market is likely to be bolstered by the development of a system for rating the ‘shade’ of a green bond.

Whether green bonds catch the eye of financial regulators or continue to be self-regulated is an open question, and one that is likely to attract further scrutiny. While all the bonds being marketed as ‘green’ still constitute a tiny fraction of the global bond market (0.04 per cent, according to one estimate), they are projected to become an increasingly significant proportion of overall climate finance, meaning concern for the integrity of this market extends far beyond the immediate parties.

Stephen Minas is a research associate at the Foreign Policy Centre, a UK-based thinktank. An extended version of this article was originally published on the KSLR Financial and Commercial Law blog.

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