6 November 2019

Green bond comment, November 2019: A market in transition

The sustainability bond markets are in a state of creative chaos and are evolving in order to stay relevant, argues Peter Cripps


The sustainability bond markets are going through a state of profound reflection, soul searching and innovation.

The market is little over a decade old and has already evolved rapidly, most recently by expanding to include social bonds, sustainability bonds and Sustainable Development Goals-linked bonds.

But 2019 has seen an unprecedented flurry of innovation and experimentation. At the same time, people are questioning the merits of the green bond market. These two developments are linked.

The green bond market is looking for ways to respond to the growing urgency of the climate crisis, the growing clamour for action, and the growing sophistication of investors.

This is to be welcomed. The market needs to evolve, or become obsolete.

Here are some key developments of recent months.

“The green bond market is looking for ways to respond to the growing urgency of the climate crisis, the growing clamour for action, and the growing sophistication of investors. This is to be welcomed”

It's all about transition!

Transition, transition, transition. The shift to a low-carbon economy is a hot topic at the moment.

You can see that by the number of opinion pieces written for Environmental Finance in recent weeks:

- Axa Investment Managers' Yo Takatsuki penned some draft guidelines for issuing transition bonds.
- BNP Paribas' Herve Duteil outlined his thoughts on how transition fits into green finance.
- Climate Bonds Initiative's (CBI) Manuel Adamini outlined an initiative to engage with some of the biggest polluting companies.
- The European Bank for Reconstruction and Development's (EBRD) Isabelle Laurent and Carel Cronenberg explained their approach to their inaugural Green Transition Bond.
- Nordea's Jacob Michaelsen argued that the debate around transition bonds is too narrow.

This debate is fundamentally about whether another transition bond label is needed to run alongside the green bond market.

Takatsuki points out that dirty issuers, particularly in the energy sector, are being shunned from the green bond market because the companies are not green. Yet he argues that these companies nonetheless have an important role to play in the transition to a low-carbon economy.

Interestingly, an example of a transition bond was issued in recent weeks. Teekay Shuttle Tankers, a Canadian shipowner specialising in oil and gas transportation, issued a €125 million green bond to fund the building of new, more fuel-efficient tankers.

The bond carried a green, rather than a transition, label. Cicero awarded it a 'light green' certification.

So, the jury is still out on whether a separate transition bond market will emerge.

Sustainability-linked bonds

Enel's sustainability-linked bonds have opened another debate for the market.

The Italian utility has previously issued green bonds to help finance its renewables activities. But it has shifted to a new format with its most recent issues, which will see the coupon rise if it fails to hit renewables targets.

To me, it was only a matter of time before this kind of issue was brought to market. After all, it had been tried and tested in the sustainability-linked loans market.

Yet it elicited a strong reaction. One news site claimed that it marked the death of the green bond market, although this was refuted by market participants.

And Nuveen's Stephen Liberatore, who runs one of the biggest green bond mandates in the market, branded it greenwashing, describing it as Enel buying an option on failing to hit its targets.

Two Degrees Investing Initiative's Stan Dupre hit back, repeating his claims that it is the concept of green bonds that is greenwashing.

I think this new format will prove popular because there are several advantages for issuers – no ringfencing of proceeds is required, and the bonds can be bigger because they are not limited to finding eligible use of proceeds.

Investors will feel happy that this type of issue incentivises issuers to make sustainability improvements, although they may feel uncomfortable that they could get higher returns if the issuer fails to make these improvements. (I understand that banks that issue sustainability-linked loans are already having to grapple with this moral dilemma. One told me they are discussing whether any extra interest payments they receive in the event that sustainability targets are missed should be donated to charity.)

A proliferation of labels

The number of labels keeps on growing.

Deutsche Kreditbank, for example, this week issued its inaugural 'blue' social pfandbrief.

Other new labels have included a Climate Action bond (Italian oil and gas firm Snam), and a Sustainable Transition bond (Brazilian beef firm Marfrig).

More recently EBRD issued the first ever climate resilience bond, based on the CBI's climate resilience principles.

This proliferation of labels is complicating the market – one market participant described it as splitting hairs.

“The number of labels keeps on growing”




Some concluding thoughts

So, where does all of this leave the green bond market?

All this innovation and experimentation reflects the fact that the market is in a state of creative chaos. There is a welcome focus on what the market is trying to achieve.

The market is broadening its ambitions and is trying to do more than simply connect green investors with green assets.

It has realised that in order to be relevant, it needs to actively help the transition to a lower-carbon economy.

That is a good thing, because more and more people are questioning green bonds. What is the point of a label?

Dupre is its most vocal critic. But this question has been a recurring theme at our conferences this year.

Tim Romer, CEO of Fundamental Infrastructure Opportunities, told our Green Bonds California conference that the green bond concept could only go so far, and he called instead for "radical transparency" throughout the bond market.
"We should start to think about green bonds 2.0," he said.

The conferences also heard that investors no longer look just at the use of proceeds. They also look at the issuers' overall sustainability credentials.

For that reason, I suspect that some of the green bonds that were issued without controversy in the early days of the market would fail to live up to the expectations of most investors today.

But if green investors are looking at the environmental, social and governance (ESG) profile of the issuer and not just the green 'use of proceeds', then that again raises the question: what is the point of the green label or the green use of proceeds format?

One of the key ways in which the labelled bond market can play a role is that it can help facilitate dialogue between issuers and investors, and this dialogue must be about the sustainability strategies of the issuers and not just the use of proceeds.

This is perhaps not adequately picked up in ESG ratings, and is where this market can add value. In fact, it is where the market must add value if it is to survive.

Peter Cripps is the editor of Environmental Finance


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