Growing pains: tougher standards needed to keep the green bond market on track

Demand for green bonds has soared in recent months – but it is becoming difficult to tell whether these bonds are truly delivering on promised environmental benefits. It’s time for more rigorous standards.

5 minute read

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In July 2016, Bank of China raised just over $3 billion with a multi-tranche bond issuance across various maturities and currencies. The deal was the largest ever international issuance of green bonds – securities designed specifically to raise capital for projects that benefit the environment.

Bank of China’s massive green-bond deal speaks to a growing trend.  Global issuance of green bonds in the first seven months of 2016 has already reached $44 billion, surpassing 2015’s full-year total of $41.8 billion.[1] And the market is attracting a greater range of issuers than ever before, from governments and quasi-sovereign institutions to municipalities and private companies.

Green bonds are structured much like any other government or corporate bond, with defined coupons and maturities. However, issuers are required to use the proceeds of the bonds to fund ‘green’ projects, such as renewable-energy technology or clean transport infrastructure. Investors are promised stable long-term returns – along with the reputational boost that investing in green bonds can provide, which is becoming increasingly important to clients.

While the growth of the green bond market is welcome, more must be done to ensure that these bonds deliver on the environmental benefits they promise. There are currently no standardised criteria governing how green bonds should be defined or how the impact of the projects they help fund should be assessed. Put simply, while conventional bonds are usually much alike, every green bond is green in its own way.

Unless more rigorous standards are introduced, the reputation of green bonds may suffer, damaging both issuers and investors.

Green shoots

Once the preserve of specialist ethical investors, green bonds took off in the late 2000s, when quasi-sovereign institutions such as the International Finance Corporation, an arm of the World Bank, and the European Investment Bank started issuing debt to fund green projects. These bonds entered mainstream bond indices and caught the attention of large institutional asset managers.

The market has grown exponentially since then. In 2012, issuance of green bonds totalled $3.5 billion; in 2016 issuance is likely to approach $100 billion, according to the Climate Bonds Initiative, a research organisation.

A range of issuers now tap the green-bond market. In February 2016, for example, the New York Metropolitan Transportation Authority issued $500 million, targeting institutional investors and individual citizens – particularly those among the sustainability-conscious ‘millennial’ demographic – keen to contribute to a project to upgrade the city’s public transport system.

Large multinational corporations such as Apple, Toyota and Unilever are also getting in on the act. Greater corporate issuance is expected following the UN agreement on climate change reached in Paris in December 2015, which was endorsed by 800 non-state actors, including some of the world’s largest listed companies.  Apple cited the Paris Agreement in the prospectus to its $1.5 billion deal in February 2016, which will fund energy storage projects.

It’s easy to see the motivation for governments, cities and companies to issue green bonds – they get to raise capital and burnish their environmental credentials. But what’s in it for investors?

On average, green bonds price at similar levels to non-green (or plain ‘vanilla’) bonds of similar maturities from the same issuer. This means that fund managers can use the green bonds to satisfy investment mandates without settling for lower returns. Moreover, green bonds have proved to be robust despite their relative novelty. Demand has remained strong during periods of volatility, suggesting these bonds are aligned with a long-term trend for green investing that will outlive short-term peaks and troughs.

In 2013, for example, the US state of Massachusetts issued a $100 million green bond alongside a general obligation bond with exactly the same yield during a wider market sell-off. While the general obligation bond failed to meet its subscription target, the green bond was oversubscribed.[2]  More recently, the order book for Bank of China’s green-bond issue in Luxembourg was three times oversubscribed despite the market uncertainty following the UK’s vote to leave the European Union.

Global warming

The growth of green bonds shows that the asset management industry is waking up to the potential risks of climate change.

Research from The Economist Intelligence Unit (EIU) demonstrates the scale of the problem.[3] If the planet were to warm by five degrees Celsius between 2016 and 2100, investment portfolios would suffer $7 trillion of losses – more than the total capitalisation of the London Stock Exchange. This isn’t just because floods, wildfires and droughts will damage physical assets but because environmental changes will result in weaker economic growth, which will have knock-on effects on the financial markets. Six degrees of warming could lead to losses of $43 trillion, or more than 30 per cent of the entire global stock of manageable financial assets.

The EIU research also shows how efforts to limit global warming can mitigate these severe financial effects. If warming is kept below two degrees Celsius above pre-industrial levels – one of the key pledges of the Paris Agreement – the projected losses from climate change would be considerably reduced. The green bond market can help finance environmental projects to achieve this objective.

For this to happen, however, green bonds need tighter standards. At present, there is no universal definition of ‘green’ on which all industry participants agree. And as the market increases in size, it is becoming increasingly difficult to gauge the environmental worth of green bonds. Much of the market consists of refinancing for existing infrastructure, for example, rather than capital-raising for new projects, calling into question the ‘additional’ benefits derived from the bond issuance.

‘Green defaults’

In an attempt to bring more rigour to the market, the International Capital Markets Association (ICMA) has set out The Green Bond Principles, a set of guidelines that recommends issuers take steps to demonstrate the environmental benefits their bonds will deliver.  Specifically, the principles call for issuers to be transparent in four areas: how they will use the proceeds; how they will select the projects that will receive financing; how they will manage the proceeds; and how they will report on the ongoing environmental impact. 

Meanwhile, the Climate Bonds Initiative, a not-for-profit organisation looking to promote investment in green projects, offers certification for bonds intended to raise capital for climate-related schemes.

However, compliance with these standards is entirely voluntary – and some issuers ignore them altogether, choosing to ‘self-certify’ green bonds without disclosing how they determine their own green criteria or detailing the projects they will finance. As a result, investors are left in the dark as to whether the bond truly makes a difference to the environment. The risk here is that an issuer will make erroneous claims as to its green credentials.

If some deals turn out to be less green than they appear, the market could suffer. Although no major green-bond issuer has yet reneged on its promises, some issues have drawn opprobrium from environmental groups. In 2014, French energy company GDF Suez (now ENGIE) issued a €2.5 billion green bond to finance renewable energy projects. It used some of the proceeds to build a hydropower dam in Brazil. Environmental groups pointed out that, while the dam provided clean energy to local communities, it also caused floods that reportedly damaged the local ecosystem.  The credit risk premium on the bonds rose amid the controversy.[4]

A recent UN report stated that “the requirements needed to ensure the credibility of green bonds are…still a work in progress. Misuse of proceeds can damage reputations, if not the market itself.”[5]  But this view may be overly sanguine. What if an issuer were found to be in outright violation of its environmental promises?  

The market is unprepared for such an eventuality. Most green bond contracts do not include provisions in the event that an issuer breaches its promises – or ‘defaults’ on its green claims – and uncertainty surrounds the correct procedure for investors seeking reparations. The reputational damage stemming from a ‘green default’ would ripple through the market. Mainstream investors would retreat and green-bond issuers would find it more difficult – and costly – to locate buyers. The momentum built up over the past few years could quickly grind to a halt.

Better standards

To avoid this scenario, as a first step we believe all issuers should pledge compliance with the ICMA’s Green Bond Principles.  The ICMA does not outline a single set of criteria for ‘greenness’, nor does it provide any guidelines for how the principles should be enforced. But the GBP could act as a focal point for greater harmonisation of standards in the absence of top-down government-led regulation. This should help make issuance more transparent and reduce reputational risk. About 95 per cent of global green bond issuers already pledge to comply with the principles; we would like to see all issuers do so.

Secondly, we would like to see the practice of third-party verification and auditing of green bonds becoming the norm across the market. Independent third-party auditing would bring much-needed reassurance to investors by measuring issuers’ claims against the environmental benefits their bonds deliver. The Climate Bond Initiative provides a list of ‘approved verifiers’ that investors can choose from to help them assess their green investments.[6]

Thirdly, we believe contracts should include standardised language that clarifies the procedure in the event the proceeds of a green bond are found to be misused. The language should ensure that investors’ and issuers’ interests are aligned. Dispute-resolution mechanisms will also be important.

The growth of green bonds has been one of the most exciting developments in debt markets in recent years. It is time to harness this and ensure it serves the best interests of issuers, investors and the environment. The Paris Agreement saw governments, cities and companies come together to promise redoubled efforts to tackle climate change. With greater transparency and more harmonised standards, the green-bond market could help them deliver on this promise.


[1] Climate Bonds Initiative

[2]‘2013 Overview: the Dawn of an Age of Green Bonds?’, Climate Bonds Initiative, 2014

[3] ‘The Cost of Inaction: Recognising the Value at Risk from Climate Change, The Economist Intelligence Unit, 2015

[4] ‘Beyond Transparency: Unlocking the Full Potential of Green Bonds’, Institute for Climate Economics, June 2016

[5] ‘Green Bonds Can Drive Low Carbon Economy After Paris’, United Nations Framework Convention on Climate Change, July 2016

[6] ‘Approved Verifiers Under the Climate Bonds Standard’,

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