The market needs to embrace general purpose bonds from 'pureplay' green companies, as well as allowing non-clean companies to issue green bonds if they are in transition to a greener business model, argues Ulrik Ross
The green bond market is continuing to grow at pace, but how much faster can it grow? And, perhaps more importantly, what developments are needed to deliver the scale to move from niche to mainstream?
Since the industry came together to create the green bond Principles (GBPs) last April, green bond issuance tripled to $36 billion at the end of 2014.
While we expect growth to continue, we are well short of the estimated $1 trillion of additional annual investment the UN says is needed to restrict climate change to below 2°C.
While we are impatient for additional success, the green bond market has already helped both to create awareness around the need for sustainable investments, and has acted as a facilitator for encouraging finance to flow towards more sustainable uses.
As the market evolves, investors will push for more transparency and mechanisms that give greater comfort to investors. Green bond issuers are encouraged to consider second party opinions, audits and impact reporting. In addition, issuers need to be mindful of the selection criteria for various sustainable indices, and any unsolicited green bond ratings.
To support environmentally damaging industries to become cleaner has to be part of the goal.
Leading issuers such as IBRD, IFC, EIB and KfW have set a new standard of best practice. However, has this set expectation too high for new issuers, and are we in danger of killing the market before it takes off?
It is important to remember that the GBPs were established without regulatory intervention. The model works because an issuer who does not align themselves to the GBPs can expect investors not to trust their credit and, potentially, not invest again. In that way, the GBPs help to generate trust, in addition to their core mission of facilitating financing for projects with environmental benefits and creating awareness of the green bond market.
Growth, transparency and quality are the key elements of the green bond market. We need a balance between them with the flexibility to avoid creating barriers of entry to new issuers. Provided expert opinions are available (via external parties such as the Centre for International Climate and Environmental Research Oslo (CICERO), Oekom, the Climate Bonds Initiative etc. or best-in-class internal expertise as demonstrated from institutions such as the EIB), it's for the investors to do their own additional due diligence, in line with standard practice to evaluate other risks.
I would also argue that the GBPs need to embrace general purpose bonds if the issuer is considered 'pure-play'. This should be defined as a legal entity with greater than 90% of activities (in terms of revenue) within eligible environmental categories (excluding financing of other companies and dividend payments to non-pure-play companies).
Another area for development is to allow non-clean industrial companies to issue green bonds. We should not limit the underlying company's potential to access the green bond market, if the transition story to a greener business model is genuine and strong. To support environmentally damaging industries to become cleaner has to be part of the goal.
Recently, China has emerged as a potential game-changer
Furthermore, 100% refinancing should be seen as a good thing. I see no additional benefit in a company issuing a green bond before it gives a loan or makes an investment, compared to disbursing the loan or investment first and doing the green bond after. The overriding priority must be to support financing with an environmental benefit.
The above sets out ideas for building on the current format of the GBPs, while ensuring issuers are not dis-incentivised to participate.
And while we are still a long way from the scale we need, recently China has emerged as a potential game-changer: setting out the steps towards greening its financial system. If China throws its considerable weight behind an incentivised green bond market, the transition to a lower-carbon global economy may well be within our reach.
Ulrik Ross is managing director, global head of public sector and sustainable financing, capital financing at HSBC Holdings plc