31 October 2019
Now that the G-word has been dropped, let's talk about it, says Stan Dupré
Quoted by Environmental Finance last week, a representative from the green bond investor Nuveen charged that the "SDG-linked bond" recently issued by Italian electricity giant Enel amounted to "greenwashing."
The first-of-its-kind bond is linked to a commitment to increase the coupon by 25 basis points if the company fails to meet its renewables capacity development targets by the end of 2021. A Nuveen representative argued, "That is not a green bond to us. If you want to issue a green bond, then issue a green bond funding the direct projects that are transitioning them to 55% renewables." He added, "Effectively, all they have done is pay ... an option on not delivering their renewables goals".
So now that the "G-word" has been dropped, it might be the right time to ask: in many ways, isn't the 'green bond' concept itself a form of greenwashing?
Indeed, contrary to Nuveen's statement, most green bonds are not "funding the direct projects" that are transitioning issuers towards renewables. In fact, they're based on the concept of "use-of-proceeds," in which green projects are not "financed" by the bonds (as in the case of project bonds) but simply "earmarked." This means that the bond proceeds finance the entire balance sheet of the issuer, including its brown investments. As a result, green bond issuers do not necessarily have to be aligned with the goals of the Paris Agreement, nor even be transitioning towards these goals.
As we discussed in our 2018 paper, "Shooting for the Moon in a Hot Air Balloon", this loophole has three major implications:
1. Both issuers and investors can say that they are "going green," even while their investments remain aligned with a 5°C scenario and are not getting any greener. This is the very definition of greenwashing.
2. Risks associated with earmarked green projects still sit on the issuer's balance sheet, which means that no de-risking takes place.
3. Green bond investors remain exposed to both the green and brown assets of the issuers, just as when they invest in standard bonds.
Consequently, there is no evidence that green bond issuance contributes to scaling up green projects. Of course, green bond advocates argue that the momentum will eventually create a "pull effect" that will, in turn, incentivise issuers to invest more in green projects. However, at this stage we think this remains nothing more than a theory, and based on my experience there is little desire to check it.
"There is no evidence that green bond issuance contributes to scaling up green projects"
Indeed, in the context of the former member of the European Commission High-Level Expert Group on Sustainable Finance (HLEG), I suggested a number of options to fix this loophole: for instance, introducing an obligation for issuers to report on the alignment of their investments with the Paris Agreement, or developing empirical research to ensure that green bond issuers boost their green capex plans above market average.
Yet all of these ideas received strong pushback from green bond promoters in the HLEG in the name of prioritising market growth. In the end, the debate was muted in the final HLEG report and taken off the table for the Technical Expert Group.
Given the context, one would think there would be more momentum to crack down on misleading marketing claims. However, our upcoming paper on the legal compliance of environmental marketing claims in Europe, slated for November 2019, reveals that most green bond funds make impact-related claims – and that 100% of those claims can be categorised as "misleading" or "false" from a legal standpoint.
In other words, many of the claims made by green bond fund managers are greenwashing, in a way that breaks the law.
Faced with these market dynamics, we think that Enel's bond represents healthy progress. For one thing, it's linked with issuer-level targets, which is more consistent with the "general purpose" nature of the bond. For another, it introduces a new incentive for the issuer to meet the target, rather than nothing.
However, that's not to say that it's perfect. Notably, we think that commitments on renewable energy should be combined with commitments on fossil fuels, in order to contribute to the broader goals of the Paris Agreement rather than cherry-picking a given technology.
So, what's next? Eventually, I anticipate that as issuers run out of green projects to earmark, and investors face increasing backlash about their marketing claims, a new kind of solution will emerge: bonds linked with the commitment to align investments with the Paris Agreement.
If introduced, this new generation bond would address many of the loopholes with green bond labeling, in turn helping us progress towards the end goal: greater impact in the real economy and better management of climate risk.
Stan Dupré is CEO and founder of 2° Investing Initiative, and a former member of the European Commission High-Level Expert Group on Sustainable Finance (HLEG).
NB: The author of this op-ed and the 2° Investing Initiative do not have any business relations, financial interests, or other affiliations with Enel. The opinions expressed in this article are the author's own and do not necessarily reflect the official policy or position of the 2° Investing Initiative's funders, members, or partners.