By Mateusz Frączek | 5th December 2019
Media sources all around the globe frequently turn to environmental crises as a topic for their headlines. The burning of the Amazon rainforest, toxic smog in Deli and Antarctica’s ice caps melting at record high rates are just a few examples of the consequences of human exploitation of Earth’s natural resources. There is a need for action and in recent years, it seems that the first tentative steps towards a solution are being made.
Green bonds are similar to those that have been around for decades: an investor buys into the security by lending their money to its issuer and they are rewarded with an interest payment based on this amount. If the issuer doesn’t default on these payments, investors should expect to receive them at regular intervals in time leading up to the bond’s maturity, upon which they would receive all of their initial investment.
However, the key distinction of these instruments is that they are dedicated to financing initiatives that tackle environmental problems. In the past, governments, non-profit organisations and corporates have issued these bonds with goals such as improving energy efficiency, reducing pollution levels in certain areas and engaging in sustainable water management.
Green bonds have typically offered a lower interest rate on average and they function in an underdeveloped second-hand market, meaning that the investor will probably hold the bond until maturity. Demand for these securities should appear to remain very low. After all, who would want to earn less for being less liquid?
But this does not seem to be the case. Fortunately for our Earth, the market has grown exponentially since the World Bank’s introduction of the financial instruments in 2008. According to Bloomberg, a cumulative $580 billion in green bonds were sold by 2018 with Moody’s estimating this year’s value to grow to above $200 billion. Apple has also recently priced its first euro-denominated bonds at €2 billion. There is certainly a growing interest in this area.
Although the idea behind issuing green bonds seems to be noble, there is still an unsolved question hanging over the financial instrument. Precisely, how do we decide if a bond is green or not?
The majority of issuers say they follow the Green Bonds Principles, endorsed by the International Capital Market Association in 2014, to bring transparency to the market. These principles encompass three important reporting elements: the desired and actual use of proceeds as well as the process of selecting a project that is used to help the environment. Furthermore, advisory companies such as Moody’s Investors Service or the Climate Bonds Initiative are willing to assist companies to ensure their compliance.
However, as these principles are not enforced and there are no standardised rules in place, the interpretation of a green bond can vary significantly. It is possible to mislead investors and unfortunately, these are not rare occurrences. According to Bloomberg Businessweek: "China, the world’s biggest carbon emitter and No. 2 green-bond issuer, has faced criticism for using green bonds to finance coal-burning power plants, even if the new facilities are cleaner than predecessors".
Sometimes, companies try to greenwash their environmentally harmful action as well. This can be seen with Enel, an Italian electricity provider, that was criticised for issuing their green bond that is committed to assist them in reaching certain renewable energy targets by 2021. This bond isn’t dedicated to financing projects that benefit the environment, so is it really green? With no restrictions on the market, Enel has the freedom to use the proceeds to finance anything on their balance sheet.
It is clear that some regulatory measures must be considered and, with appropriate management, green bonds could be at the forefront of solving worldwide environmental issues. But without backing from major governing bodies, the market’s integrity could be further compromised. The hope of an effective solution for climate change would be harder to hold on to.
Ultimately, despite green bonds gaining traction, economists and environmentalists often conclude that until the market reaches a $1 trillion valuation, there is yet to be a large impact solely based on how socially responsible corporates and governments claim to be. Nevertheless, with the possibility of even a low return, the increased funding that green bonds have provided is worth something. Every $1 spent on improving our environment provides a better outlook on our future.