Sean Kidney, CEO and Co-Founder at the Climate Bonds Initiative candidly tells Treasury Today that more needs to be done to promote green bonds if we are to halt the negative impact that humans are having on the planet.
What makes a bond ‘green’ and what is the difference between a labelled and non-labelled green bond?
In theory, a green bond is a bond issued by a government, corporation, financial institution or bi-lateral organisation with the proceeds being invested in green projects. In practice, however, the definition is more nuanced.
This is because green bonds typically come in two forms. There are labelled green bonds – bonds that conform with ICMA’s Green Bond Principles. And there are non-labelled green bonds – bonds that were not marketed as green and do not comply with these principles, but where the bond proceeds are going directly to green projects, wind energy project bonds for example. We call these “climate-aligned” bonds.
In 2016, US$93bn of labelled green bonds were issued by a range of companies around the world. These though only accounted for 17% of climate-aligned bonds - most of the bonds issued were non-labelled.
If an investor is willing to do the due diligence on climate-aligned bonds then there is a much bigger pool to choose from than green-labelled. Solar company bonds could be regarded, for example, as green by default. Even if they are just funding working capital through the bond, these companies are still investing in green projects, meaning their bonds can be classed as green.
However, many investors say that they prefer to focus on labelled green bonds as it is easier to report back on these to their clients. It makes their lives easier as it reduces friction.
Reducing friction is always important to growing markets. Labelling will, therefore, be very important going forward in bringing in more investors.
Why is the green bond market seen as an important weapon in the battle against climate change?
Climate change is an extraordinary challenge facing the world community, fuelled by a mix of continuing increases in anthropogenic greenhouse gas emissions and environmental feedback loops that threaten uncontrollable change.
To prevent this there needs to be a rapid and global shift from emission-producing to clean-energy generation.
A recent International Energy Authority report estimated that US$10.5trn is required in the coming two decades to fund the transition to a low-carbon economy, at a pace rapid enough to head off runaway climate change. A major report conducted by WWF corroborated that figure.
There are not adequate public funds to meet this challenge; that means engaging private capital, including the largest market of all, the US$100trn bond market.
Hitting this target would require investment equivalent to 1.5% a year of the world’s institutional investment fund assets, every year for just ten years. This can’t be just a niche solution; mainstream portfolios need to be engaged.
A green bond is designed to do exactly that: it has a risk and yield comparable with other bonds, with its contribution to addressing climate change being an “added bonus”. That allows investors to meet short-term portfolio management requirements while also helping to address the long-term risks of climate change. In the wake of the Paris Climate Agreement it also helps a little with risk mitigation – green bonds are less likely to encounter policy risk as a result of governments moving to meet Climate Agreement targets.
What more needs to happen to help the market grow?
Despite good progress in recent years, the green bond market is still far too small to achieve these global goals. If we are to shift our economies at the speed and scale needed to stop the planet becoming uninhabitable in the second half of the century then we need to do everything that we can.
The whole system, including regulators, issuers and investors, need to act together and drive this shift towards green. China, where the government is regulating the green bond market, is setting a precedent that other countries should look to emulate. There are other positive signs of regulators seizing the initiative, like the Monetary Authority of Singapore, which is offsetting the costs for green bond issuers to push the market forward.
To grow the market in new locations there also need to be more projects that are ‘bondable ready’, especially in regions like Africa and Latin America. Unfortunately, adequate levels of project expertise in these markets do not exist, so progress is slow.
It is clear though that the demand for green paper is there and it outstrips supply so now really is the time for the financial system to act and become green.