How green are green bonds?

By David Walker

The market for green bonds is growing like weeds. These bonds finance assets everywhere from central Hong Kong to Outback Australia, and are generally oversubscribed.

The flood of money is coming particularly from institutional investors – in Australia, from First State Super, AustralianSuper, BT and the like. They feed the paper into the asset base of their sustainable and ethical funds, the ones that mum-and-dad investors buy everywhere from Los Angeles to Dusseldorf.

These green bonds are pitched as delivering green solutions, and sometimes as combating climate change. ABN AMRO Bank, for instance, says its issuance of green bonds, focused on renewable energy and energy efficiency in the built environment, will let clients and investors “contribute to international greenhouse gas reduction targets”.

Kyung-Ah Park, the head of Goldman Sachs’ Environmental Markets Group, calls green bonds “a powerful tool... to shift capital towards positive environmental impact”.

A study of green bonds by two Harvard Business School professors, Malcolm Baker and George Serafeim, says that in the absence of a global carbon pricing scheme, “bond markets will be central” to financing climate change mitigation and adaptation.

Yet the effectiveness of green bonds remains in doubt. When a 50-year-old doctor in Sydney’s Mosman or Hong Kong’s North Point clicks the button to move their investments from the FundInvestCorp Brown Industry Fund into the FundInvestCorp Green Sustainability Fund, the funds available for green assets generally won’t change.

Is this making the world any greener? In the green bond world, they even have a name for the question: “additionality”.

Greener at the margins?

The first green bond was issued in 2007 by the European Investment Bank. By 2016, with a lift from the 2015 Paris Agreement on climate change, issuance was approaching US$100 billion. In 2019, several forecasters say annual issuance may top US$200 billion. Larger corporate issuers range from French rail company SNCF to tech giant Apple to Chinese banking colossus Industrial and Commercial Bank of China (ICBC). In Australia, green bonds have ranged up to TCorp’s A$1.8 billion offering last November.

TCorp’s Katherine Palmer, senior manager of funding and balance sheet, reports the offer was oversubscribed within the first day.

Yet only at the margins is all this lowering emissions and making the world greener. For a start, the global bond market is more than US$100 trillion in size; green bonds remain at far less than 1 per cent of it.

Making the picture more complicated, green bonds don’t actually finance new assets. Eliza Mathews, Westpac’s director of sustainable finance and one of Australasia’s most experienced green bond financiers, says that like most bonds, green bonds are generally used to refinance an asset after it has been built, with finance from mostly un-green sources.

Where's the premium? 

Then there is the pricing. Most analysts agree you won’t pay noticeably more for green bonds than for ordinary bonds. One study does show a small premium in the US municipal bonds market.

However, ratings service S&P said in a February report that “the evidence of a ‘green premium’ vis-à-vis plain vanilla debt is only anecdotal, and so far appears inconsistent and statistically insignificant”. Mathews says Westpac expects to issue green bonds in line with vanilla bond pricing. Emma Herd, CEO of the Investor Group on Climate Change (IGCC), says it’s a constant question as to when the premium will emerge, but it hasn’t yet.

This may seem strange to a green bonds newcomer. If green bonds consistently sold at a premium – that is, delivered investors lower yields – they would have a clear purpose: cheaper funds for green projects. Yet green bonds sell at a similar yield to conventional bonds, which require no green behaviours. Then why not just fund green projects with vanilla bonds?

One answer is that issuers offer good terms in a new market and are keen to diversify their list of bondholders. A second is that green bond offerings may have lower environmental risk.

The most important factor in green bond pricing, however, seems to be that the green label has its own market value.

An Edelman PR group report in November 2018 found that almost 90 per cent of institutional investors around the globe had changed their voting or engagement policies in the previous 12 months to pay more attention to ESG (environmental, sustainable and governance) considerations. Herd says European investors in particular are “aggressively looking for green bonds”. Palmer observed demand both from big funds and from smaller dedicated ESG funds. Hong Kong-based institutions, too, are extremely aware that they need to be environmentally conscious, says the Hong Kong-based chairman of Green Park Financial Group, Eden Wong FCPA.

The current lack of a green premium means institutions can also promise that savers won’t lose any of their retirement savings by going green. That matters: research suggests investors want greenery, but don’t want to sacrifice returns.

You may say the investment market has responded efficiently, finding a relatively low-cost way to put a green label on investments.

However, when investors commit money with green intent for a project that has already been built and that will be no cheaper because of green bonds, then it’s unclear how that improves environmental outcomes. It’s certainly hard to find a green project that would not have been built without green bonds.

The challenge of policing green bonds

Any bond is a promise to pay. A green bond makes an enhanced promise not just to pay, but also to use the bond’s proceeds for green purposes. This requires that the purpose be genuinely green, and that the funds actually be applied to that purpose and properly reported on. That involves tough policing.

The most widely accepted standards for greenness are the Green Bond Principles set down by the International Capital Market Association (ICMA), and the Climate Bonds Standards of the Climate Bonds Initiative (CBI).

Most green bonds in Australasia accept those standards and set down independent audit and assurance processes to ensure they are met. Herd says Australia’s processes for meeting those standards are among the world’s best. She knows of at least one deal that financiers ultimately decided would not support green bond issuance. That rigour, she says, is one reason Australian green bonds have done so well: overseas investors believe they’ll get genuinely green spending.

Even with those standards, the greenness of green bonds is not always clean-cut. Like most bonds, green bonds are generally used to refinance an asset after it has been built with finance from mostly un-green sources.

For example, Australian retailer Woolworths Group raised A$400 million in early 2019 through a green bond and promised to use the proceeds for solar panels and more efficient LED lighting. Its green bond was certified by EY in a “reasonable assurance” statement as meeting the ICMA and CBI standards. Among other things, EY examined Woolworths’ published framework for how it would use the money. Woolworths will report annually on its use of the proceeds.

However, Woolworths owns more than just a collection of large suburban grocery stores. It owns the ALH Group gambling business and the BWS and Dan Murphy’s liquor chains. Did people investing in a green or sustainable portfolio expect to assist in installing new light bulbs above the poker machines or in the cut-price whisky aisle?

Some Australian investors, including Perpetual Limited, reportedly passed on the offering for just this reason. Coincidentally or not, Woolworths now plans to shed all three of those businesses.

On the other hand, Australian standards outstrip those of the Chinese market. There, “green bonds” have been issued to fund reductions in emissions at coal-fired power stations – a use that rigorous certifiers such as CBI wouldn’t allow.

The dominance of buildings

Another challenge is that green bond money is often spent on what looks like mainstream uses, where green standards are advancing without green bonds help. Woolworths, for instance, said it might spend some of its green bond on “development of low-carbon supermarkets” – new supermarkets whose emissions are relatively low and decline over time. However, since lowering supermarkets’ energy use can raise the owner’s profits substantially, supermarket groups in many regions have already begun reducing their energy intensity.

Moody’s Investors Service reported last December that renewable energy – probably the sort of investment most people think of green bonds as funding – claimed 17 per cent of green bond financing. Clean transport took 15 per cent. Yet 52 per cent of the green bond finance assessed by Moody’s ended up being spent on buildings, whether on new buildings or on improving efficiency in existing ones.

Arguably, this is genuinely pointing the money at the real problem. According to ABN AMRO, real estate in the Netherlands is responsible for 40 per cent of its carbon emissions. Yet the dominance of building projects in green bonds is also, as Mathews puts it, “a function of the ease of being able to find those assets”.

The crunch question for green bonds

There’s no doubt some of those involved in the field believe they’re making a difference. Mathews, for instance, is “really excited by what green bonds have achieved and what they can continue to achieve”.

The ultimate question for green bonds remains: have they enabled anything that wouldn’t have happened without them?

Are they an answer to the “additionality” question? It’s certainly hard even for market veterans to find anything. Herd says green bonds have played “a really important part” in pushing companies and governments to begin looking for projects to invest in, and getting capital deployed quickly into green assets. Yet, pointing to a particular asset that owes its existence to green bonds is “challenging”.

“Would a green asset have not gone ahead without a green bond?” Herd asks. “That’s still an interesting question. I’m not sure.”