Green bonds shake off ‘niche’ shackles

Recovering stronger than traditional debt

Green bonds look to have firmly left behind their ‘niche’ label, with one in every €4 raised by companies and governments in Europe last quarter achieved via these debt structures.

In the second quarter of 2022, $192bn of green, social and sustainability bonds were issued compared with $225bn in the first quarter.

That’s not the full story either, issuance of green bonds in particular held up better than more traditional debt instruments – up 25% in the second quarter compared to the first quarter. But the sector is still lagging its 2021 highs, with year-to-date issuance for the first half of 2022 just shy of $220bn, marking a 21% decline versus the same period last year.

Geopolitical tension, inflationary pressures and the most recent energy crisis have negatively affected capital markets globally, with barely an asset class left unscathed, and green bonds were no exception. But it is still encouraging to see the second quarter recovery in issuance for green debt dealmaking, especially since this recovery was stronger than the traditional segment of the market, which only saw an increase of 15.8% quarter on quarter.

Avoiding ‘greenwashers’

Yet, inevitably, with greater profile comes greater scrutiny. And tackling greenwashing is now a priority for investors and regulators keen to recognise more easily which bonds are greener than others.

For this, we recommend investors not only consider the bond itself but also the issuer. A good starting point is to evaluate how environmentally impactful the specific projects linked to the fund raise are likely to be, then assess how well these projects align with the issuer’s overall sustainability strategy.

The proceeds raised from issuing green bonds should certainly be earmarked for specific activities, but if these initiatives are incongruous with the business’s long-term environmental efforts, then that would suggest a lack of coherent sustainability strategy and the potential for greenwashing down the line.

Post-issuance impact reporting practices are another core component investors should not overlook. Despite not being enforced by external standards, recording and reporting the positive impact of green bonds is becoming critical to demonstrate the genuine impact of projects. For professional investors in particular, who are facing growing regulatory scrutiny on sustainable finance practices, access to this level of detail is vital.

Long-term structural support

The European Taxonomy, the rulebook that classifies ‘green’ activities, is also helping investors assess how green the projects of a bond are, while the Sustainable Finance Disclosure Regulation is incentivising fund managers to disclose their sustainability assessments and the environmental credentials of their portfolios.

Despite the lower-than-expected primary market activity in 2022 so far, the direction of travel is clear, with green bonds expected to play a major role in confronting the unprecedented climate challenge ahead.

According to the International Energy Agency, 1.5% of global GDP should be directed towards fighting climate change. Of this, only part will be financed by governments, while more and more investments flowing from the private sector will be needed to support the transition efforts.

Green bonds will continue being one of the most effective instruments to ensure this required capital flow.