If issuance activity is anything to go by then the green bond market would appear to be in good health.
Columbia Threadneedle Investments reported that a new daily issuance record for green bonds was set on 21 May, following five issues from sovereigns, local governments and corporates worth more than €8bn.
But at the same time, a growing number of experts in the industry are warning about the quality and transparency of those issues, including Xavier Ledru of banking group REYL & Cie.
In a market insight paper for July and August 2019, titled ‘Sustainable bonds and loans: Can we achieve more?’, Mr Ledru said the rules that apply to issuers or borrowers of green, social and sustainability bonds need to be “stricter” to ensure these instruments meet their goals.
In the paper, he calls for “appropriate incentives” and set outs that “failure to report or justify that the proceeds of a given bond or loan are used in accordance with the legal documentation, could justify an increase in the spread of the relevant instrument, or additional financial (or other) covenants or undertakings”.
Mr Ledru points to the practice known as “green washing”, where funds raised under a green, social or sustainability bond or loan are not applied consistently, or when an organisation represents its activities or policies as producing positive environmental outcomes when this is not the case.
At a crossroads
In June this year, Axa Investment Managers proposed a new “transition bond”, with the idea being carbon intensive companies issue debt that will help them become greener businesses.
According to Yo Takatsuki, Axa IM head of ESG research and engagement: “Transition bonds would allow the quality of the green bond market to avoid being diluted by issuances where the environmental benefit of projects being financed is less clear.
“The concept of the green bond has been proven; it works, and it is here to stay, but that market is now at a crossroads.”
Russ Mould, investment director at AJ Bell, says the Green Bond Principles already exist to promote and maintain integrity in the green bond market and are reviewed and updated regularly.
“In the end, the market will hold issuers to account. If investors are not happy with an issue or issuer then they will demand a higher coupon to compensate themselves for the perceived risk involved with holding the paper,” he says.
But Mr Mould adds that this year’s surge in green bond issuance “could prompt more cynically minded investors to think that some firms are jumping on a convenient and fast-moving bandwagon to gain access to capital at a time when investors are hungrily searching for yield.”
The green bond market does need to be held to higher standards, says Joshua Kendall, senior ESG analyst at Insight Investment.
In May, Insight Investment reported that impact bonds are falling short of minimum standards for sustainability, pointing out that it had marked 10 green bonds as red on its proprietary rating scheme so far in 2019, up from just one marked red in 2018.
He says: “There is a risk, in many cases, that investors face their money being used to pay off debt rather than contribute to any environmental advances.
“This, alongside a lack of agreed standards, patchy reporting and weak commitments, is leading to a poor reputation for the green bond market.”
Doing the research
Given that investors’ interest in the green bond market is far from waning, what is the solution?
Mr Kendall adds: “Clarity in the market is needed to lead further growth, but we see developments, such as the European Commission’s green bonds standard and the UK’s green finance strategy, as providing necessary direction.”
He also points to some regional differences, with good reporting from European issuers but the US lagging.
Mr Mould suggests investors will still need to do their own research and not take labels at face value when investing in green or impact bonds.
“The ‘green’ tag can be a great marketing device but investors must still ensure that the money raised is being used appropriately and that the coupon they are accepting compensates them for the credit, interest rate and liquidity risks involved,” he says.
“They can best judge this by carefully reading all of the disclosures about the issuer’s environmental strategy and the proposed use of the issue’s proceeds. Independent third-party reports and auditors’ follow-up research should both help here and, in some ways, this provides investors with more information than the would-be purchase of another fixed-income instrument, or equity, would perhaps get.”