08 February 2018
In the classic film Monty Python's Life of Brian, a group plotting to overthrow the Roman Empire ask: 'What have the Romans ever done for us?'
After some discussion, they concede that the Romans have brought numerous benefits, leading to the line: "All right, but apart from the sanitation, the medicine, education, wine, public order, irrigation, roads, a fresh water system, and public health, what have the Romans ever done for us?"
I was reminded of this scene in a recent conversation I had with an NGO that is sceptical about the merits of the green bond market. The spokesman described green bonds as "a tool for greenwashing" and "a fig leaf for corporate polluters to hide behind".
He is not alone in this view. The main charge levelled at the green bond market is that it is not "additional", a term that refers to whether a green bond is causing new finance to be channelled towards green projects. In other words, would the projects have been built anyway, regardless of whether the green bond had been issued?
This issue of additionality was flagged in the final report of the EU's High-level Expert Group on Sustainable Finance (HLEG), which suggests the creation of an EU green bond standard could help to resolve the issue.
This question of additionality is hugely important, and it touches on a sensitive area for the green bond market because, I suspect, most green bonds fail this additionality test.
Ultimately, whether the market has a long term future depends on whether it is part of the solution to environmental problems, including how to restrict global warming to 2°C.
But, as Zurich Insurance Group's Johanna Köb argued in her excellent keynote address at last year's Green Bonds Europe conference, perhaps additionality is not a fair demand to make of green bonds. After all, bonds are generally a refinancing tool, so by their very nature they tend to refinance assets that have already been built.
That is not to say that green bonds are not a worthy endeavour. The market has made a massive contribution to the sustainable finance agenda. There are too many positive features to list them all in this article, but they include:
- In years gone by, the words environmental and finance were seen as immiscible, but the green bond market has proven that 'green finance' can work, and can raise hundreds of billions of dollars. As one investor put it: "The green bond market is the only thing out there that is doing green finance at scale."
- Green bonds have created a new way to take investors who care about the kind of companies or projects they finance and connect them with green assets. As JP Morgan's Marilyn Ceci pointed out in her comment piece about redefining additionality, they would previously have had to use sustainability consultants to assess bond issuers.
- The engagement of the capital markets in green issues has helped boost the prominence with which environmental matters are viewed in the policy arena.
- Green bonds have been a key actor in driving the conversation around the question of 'what is green?'. The asset class has helped moved these conversations away from the sustainability department and into the board room, involving the finance/Treasury departments, often for the first time. This is crucial for getting the board to buy-in to sustainability matters.
- This conversation around what is green and how green bonds are structured has led to improved dialogue between issuers and investors on sustainability matters, as Ceres' Peter Ellsworth pointed out at our Green Bonds Americas conference. Some investors, for example, view sovereign green bonds as a way to engage with countries for the first time about their environmental policies.
- The green bond market has been at the cutting edge of devising taxonomies about 'what is green?', helped by the work of the Climate Bonds Initiative and the multilateral development banks. It was striking during the work of the HLEG that when it comes to devising taxonomies for sustainable finance, the work around climate change is much more advanced than on social issues. The green bond market has played a major role in moving this agenda forward.
- The scale of collaboration inspired by the green bond market has been phenomenal. Issuers, investors, underwriters, NGOs and every other kind of player in the market have worked together to build this market, which is self-policing and, so far, has not needed government intervention or supervision. This powerful combination of actors has built the Green Bond Principles, and launched numerous other initiatives such as that on harmonised reporting frameworks. Who would have thought those most competitive of beasts – investment banks – could work together so effectively?
- The green bond market is sometimes described as "a gateway drug for environmental, social and governance (ESG) issues more broadly". In other words, the process of issuing or buying a green bond starts a conversation about sustainability matters which can lead to the development of a broader sustainability strategy, and encourage investors and companies to think about the impact of their activities.
- The infrastructure built by the green bond market has helped boost other areas of sustainable finance. For example, the International Capital Markets Association was able to roll out the Social Bond Principles largely based on the template set out by the GBPs. The basic tenets of the green bond market can also be extended to green loans. Work in other areas such as impact reporting is also relevant to other sectors.
- Because banks have been keen to issue green bonds, many of them have started to scour their loan books for green assets. This will help them as they start to assess their balance sheets for climate risk, as recommended by the Task Force on Climate-related Financial Disclosures (TCFD).
- The market has also provided countless examples of innovation, from payments that can be made in forest carbon credits or cash, to bonds whose use of proceeds include research and development.
So, actually, the green bond market has achieved much. But that doesn't mean we shouldn't push for more.
I believe that an open conversation about what the green bond market can and cannot realistically deliver is in order.
To my mind, there are numerous ways in which the impact of the market could be enhanced.
One of these is if investors start 'paying up' for green bonds. This would create an incentive for companies to fund more green projects to allow them to issue green bonds and lower their cost of capital.
Although there is growing anecdotal evidence that green bonds are beginning to attract a pricing premium, many investors argue passionately that green bonds need to price pari passu with their plain vanilla equivalents if the market is to remain sustainable.
Another way in which green bonds could be additional is if they allow fresh funds to flow to markets where there is a shortage of capital to help build green projects, particularly in developing countries. Here, surely the green bond market holds great potential. The IFC/Amundi emerging market green bond fund, due to launch shortly, will play a key role in helping scale this up. Emerging market sovereign green bonds could also be important.
I am interested in the potential for green bonds as climate risk mitigation tools. Currently, most 'use of proceeds green bonds' share the same credit risk as other plain vanilla bonds from the same issuer.
But bonds issued by 'pureplays' or green bonds that have recourse to green assets could be considered at lower risk of being rendered 'stranded assets' amid the transition to a low-carbon economy. With investors being asked to report in line with the recommendations of the TCFD, surely demand for such products will grow.
Policymakers could also, if they choose, create tax incentives for green bonds.
Happily, the apparatus to deliver all of this, and more, is already in place, thanks to a decade of hard work from market participants, exemplifying the collaboration I mentioned earlier.
That's what the green bond market has done for us!
Peter Cripps is editor of Environmental Finance
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Comment from Helena Lindahl, Storebrand Asset Management
I just wanted to tell you that I really like your latest piece on green bonds (Monthy Python).
I totally agree with you, if it were not for green bonds, we still would be in the starting block.
Comment from Manuel Adamini, CBI:
Congrats to Peter Cripps for this excellent piece, with a long bulleted lists of pros for green. We needed to put those things down on paper! And even better that Peter goes out for a kill of the often misplaced 'additionality' argument (though he could have been more forceful even…)
There's only one flaw to one of the last arguments, where Peter implies that green bonds' supposed recourse to green assets may, through a lower 'asset stranding risk', offer lower credit risk: most green bonds do NOT have direct recourse to green assets... They may have a (senior) pro rata de facto claim on green assets out of the issuer's overall balance sheet, but without formal ring-fencing that's no technical reason for (marginally) lower credit risk compared to the same issuer's vanilla debt.
Though the technical argument won't move (if you like the issuer for its green strategies, you could simply buy its non-green debt for 'green exposure'), I am convinced that a pricing differential will emerge. Issuers with a real credible transition strategy, i.e. those with aggressive grey-to-green business growth plans (that may well be funded by aggressively increasing the portion of green bond issuance out of total issuance), will represent a better (climate) risk hedge to investors than non-transitioning sector peers.
This pressure will increase over time, as the various sorts of climate risks to businesses' operations and assets, as flagged by FSB's TCFD, become ever more material to investors fast. If societal views then press investors to be keen on being seen as backing grey-to-green business transitions with their funds, then they will have an ever stronger preference for green over grey paper from the same issuer, supporting a price difference even in the absence of the green debt's direct recourse to the issuer's less climate-exposed (green) assets.