1 September 2023

On the origin of green bonds

The principles that underpin the 'use of proceeds bond market' – and the focus on the positive use of money – can be traced back to the eighteenth century, argues Chris Wigley

As interest grows in green bonds, and sustainable bonds continue to develop down new avenues, it is useful to try to investigate the essence of a green bond. To do this it is helpful to examine their origins.

The first significant date is 1760. This is the date of John Wesley's sermon 'The Use of Money', which outlines how money may be used for good purposes. Please note the similarity of the phrase 'use of money' to 'use of proceeds', which is in use today in bond prospectuses.

Wesley states: "The fault does not lie in the money, but in them that use it. It may be used ill: and what may not? But it may likewise be used well..."

Wesley continues, outlining that it's important to:

  1. Be 'clear' or transparent about activities,
  2. Have consideration for 'neighbours' or impact, and
  3. Make a commitment - when making a commitment - of 'all' or 100%.

Chris WigleyIn the nineteenth century, the focus was very much on social issues. These included the abolition of slavery, industrial injuries such as phosphate, child labour, votes for women, etc. There was also a rise in the temperance movement, which tried to raise awareness of the risk of alcoholism to families.

At the same time, Methodists in the US and Quakers developed investment strategies that excluded certain negative impact industries, for example, armaments, alcohol, gambling, etc ('sin stocks').

In 1928, the Pioneer Fund – the first ethical mutual fund – was launched in the US. It excluded investment in alcohol and tobacco. The important point here is that the fund formally applied a principle of exclusion.

1972 was possibly a pivotal date in UK ethical investment. Charles Jacob CBE – the investment manager of the Central Finance Board of the Methodist Church and a fixed income specialist who had led the gilt and fixed interest department at James Capel in the 1960s – had monitored developments in ethical funds in the US.

However, rather than depend upon a negative screen (exclusion) as in the US, Jacob preferred to also apply a positive criteria. Jacob was instrumental in establishing the UK's first ethical mutual fund – the Friends Provident Stewardship Fund – in 1984, which applied both a negative and positive screen.

Like Wesley, Jacob was concerned not only about how money was gained, but also how it was used. Later, and significantly as a fixed income specialist, Jacob stated that what is most important is not the negative use of money (exclusion) but rather the positive use of money – in line with the ethos of green bonds.

There are four further important characteristics of green bonds to highlight here:

  1. Historically, ethical money flowed to ethical equity funds because asset managers then had influence over the actions of corporates through voting rights, engagement, etc. However, in this case, investors' money was being used just to provide capital. In contrast, ethical or green money flowing to green bonds is used to fund directly – and also 100% – green projects. This has the additional benefit of relaying clearer environmental and social impacts.
  2. Additionally, bond markets can also do the heavy lifting in financial markets – potentially raising $8 billion or more to do good, and in a day and by just one issue, potentially.
  3. The 100% allocation is an essential element as, by its nature, it reduces the risk of unwanted allocation and associated negative impacts.
  4. Use of Proceeds, transparency, allocation and impact have always been the key features of green bonds, supported by the all-important regular reporting.

In 2002, following the Millennium Summit (2000) and the International Conference on Financing for Development, there emerged a search for innovation in development finance.

In 2003, the UK Treasury and Department for International Development proposed an International Finance Facility (IFF) which would be backed by government guarantees to issue bonds to fund aid.

"Social bonds came into their own during the Covid-19 pandemic when more than $200 billion of social bonds were raised to fight the virus and the social impact of the virus"

In 2004, France joined the UK and in 2005, Sweden, Norway, Italy and Spain also committed to provide guarantees. In 2006, the International Finance Facility for Immunisation (IFFIM) was registered as a charity by the Charity Commission for England and Wales and $1 billion was raised by IFFIM's first vaccine bond to fund an immunisation programme for children in the world's poorest countries – by 2015, up to 500 million children had benefited. This was the first 'social bond' and the first bond to be transparent over its use of proceeds – the clear positive use of money.

In 2007, the European Investment Bank (EIB) issued the first green bond based on the same 'use of proceeds' principle, and the World Bank followed in the following year. Scandinavian pension funds in particular were very interested in the concentrated focus of use of proceeds bonds, especially to address climate change.

Interest in green bonds further increased, and four green bond funds were launched: Nikko Asset Management World Bank Green Bond Fund (2010), State Street Green Bond Fund (2012), Calvert Green Bond Fund (2013), and Mirova Global Green Bond Fund (2015).

As the green bond market grew in size, liquidity became important and was aided greatly by new issues of more than $1 billion – IFC ($1 billion – 2012), EDF (€1.4 billion – 2013) and GDF Suez (€2.5 billion in two tranches – 2014).

Demand from investors continued to increase and green bond issuance gradually grew to the point when issuers needed guiding principles established and agreed. Consequently, the green bond Principles (GBP) – with ICMA as the secretariat – were launched in 2014 with JP Morgan, Citi, Bank of America Merrill Lynch and Credit Agricole as founding members.

The next major development in the market came in 2016 when the Social Bond Principles were launched – again with the ICMA as the secretariat. This was an acknowledgement of the importance of the first use of proceeds bond – IFFIM in 2006 – and also the emerging issuance of social bonds since.

It was understood that not only could environmental projects be funded by bonds, but also health, education, affordable housing, employment, diversity and inclusion, etc. The range of possibilities was huge, and consistent with Wesley's original principles and with Jacob's outline.

Green bonds and social bonds were deliberately kept separate by the ICMA 'Principles' – partly due to the established brand of green bonds but also due to the huge potential of social bonds to fund the eligible projects above. Social bonds could do the heavy lifting with the possibility of raising $8 billion or more in a day.

Social bonds came into their own during the Covid-19 pandemic when more than $200 billion of social bonds were raised to fight the virus and the social impact of the virus.

There is intentionally no blurring of the lines between green and social bonds, because of the understanding of the potential of social bonds in their own right. The next stage in the development of social bonds would be an independent social taxonomy.

The positive use of money and the four essential elements today of a green (and social) bond – focus on the use of proceeds, transparency, whole allocation and impact – remain consistent with original principles set out in 1760.

Christopher Wigley is a specialist in sustainable bonds.

Green Bonds
Chris Wigley