5 June 2017

Time the green bond market grew up

The exclusion of Repsol's bond from the main green bond indexes highlights that a lack of a clear definition of what is green is hindering the market, argues Keith Mullin.

The current Green Bond Principles – which provide a basis for transparency and reporting but which have never set out to define green – are past their sell-by date

The stark difference of opinion over whether Repsol's recent €500 million green bond was in fact green – it was nixed by Climate Bonds Initiative and Bloomberg and therefore automatically excluded by the indices – should mark a breaking point for this market. The hazy, ill-defined multiparty voluntary standards that underpin it create too much latitude and are unfit for purpose.

How can there still be confusion as to what a green bond is? Definitional issues are dictated by the opinions of too few who wield too much power. That can't be right for a market segment established to fund vital climate-change mitigation.

The current Green Bond Principles – which provide a basis for transparency and reporting but which have never set out to define green – are past their sell-by date. I say merge the Climate Bonds Standards with the Green Bond Principles and, perhaps working backwards from 2oC cap timelines and requirements, overlay a calibrated matrix of formal environmental impact metrics.

The green bond market needs borrowers from the brown economy if it is to serve its purpose. Not on an 'anything goes' basis but on the basis of a formal rule-set that is practical, reasonable and workable and which offers clarity for investors and certainty of outcome for issuers.

I don't know if the Repsol bond hit a reasonable impact threshold. But I am arguing that the difference of opinion around it tarnishes the market's reputation.

Repsol was the first oil and gas major to tap the green bond market. That's important. And because corporates away from renewables/real estate have in effect snubbed the market, the emergence of a core name was notable. Let's be clear: the company's Green Bond Framework is fully compliant with the Green Bond Principles and the bond got a second-opinion thumbs-up from Vigeo Eiris.

It's safe to assume the 10 underwriting banks – BBVA, Citi, HSBC, Banca IMI, BNP Paribas, CaixaBank, Goldman Sachs, Morgan Stanley, Santander and Societe Generale – backed the bond's green credentials. This is not a trivial point as any hint of collusion around corporate greenwashing comes with reputational and credibility risk.

Finally, green/ESG investors bought close to half the bonds (overall demand reached €2.7 billion).


So what went wrong? Well, insofar as the company raised capital to fund emissions reductions as planned, nothing.

But the Bloomberg Barclays MSCI Green Bond Index axed the bond from its eligible list. "[T]here is little evidence to indicate that Repsol will be utilising the proceeds of the green bond for activities that go beyond 'business as usual' (BAU) energy efficiency improvements," according to a technical note seen by Environmental Finance. Harsh. But to my point above: that's their opinion.

The difference of opinion around the Repsol bond tarnishes the market's reputation

I say Repsol's BAU is energy exploration and production. But proceeds of the bond will finance/refinance 312 projects targeting a reduction of 1.2 million tonnes of CO2 equivalent emissions, an integral component of its sustainability agenda. Can a 25%-plus target reduction in CO2 emissions by 2020 (relative to 2005) as part of a multi-year programme be considered BAU energy efficiency? Debatable. But that's my opinion.

Not green enough

While acknowledging the absence of public guidance around whether more efficient refineries are green, CBI chief executive Sean Kidney doesn't think the Repsol bond is green enough. "What Repsol is doing is an improvement, obviously, and many investors have felt it's good enough; it's just not enough in our humble view to warrant the green tag from a climate-change perspective," he said. CBI doesn't regard the bond as greenwashing but thinks the greenhouse gas savings are tinkering around the edges.

But, in the absence of any scientifically-derived impact floors hard-wired sector-by-sector into green bond criteria, CBI's exclusion is disorienting and unconstructive. What emissions reductions number would have been sufficient? CBI doesn't say. The organisation is instead calling for "wholesale business-model shifts" that will lead to "a deep, rapid and sustained reduction in emissions".

The market's abject failure to address the issue of how best to encourage fossil-fuel companies to finance their greening activities is bewildering

"We need step-change in the fossil fuel industry not incremental change. We need to be shutting down the whole sector in the 2030s. Switching to bio-feedstock? Tick. Marginal improvements in efficiency in plants? Not great. So on the basis of the precautionary principle, we are excluding [the bond] unless a stronger case can be made. We're open to that but have not seen a stronger case yet," said Kidney. (The precautionary principle is a fancy way of saying 'guilty until proven innocent').

Fine. But aspirational climate-change slogans are not reconcilable with the Realpolitik ofbond market structuring. I'm not saying I disagree with CBI's pronouncements, but the lack of specificity for bond issuers is aggravating.

"It would certainly be very useful to have a closer look at what the criteria should be in the sectors of Repsol's bond; but that will take time," Kidney said. But time is running out. The market's abject failure to address the issue of how best to encourage fossil-fuel companies to finance their greening activities is bewildering.

Circle of doom

What has conflated the issue is that CBI and Bloomberg inform or supply data to the green bond ecosystem thus have a highly leveraged impact. "The [Repsol] bond has not been flagged as 'green' by the Climate Bonds Initiative. We rely on the judgement of the CBI in this respect," said a spokesperson from Solactive, which publishes the Solactive Green Bond Index.

This was echoed by an S&P Dow Jones Indices spokesperson: "One of the eligibility criteria for our S&P Green Bond Index and S&P Green Bond Select Index is for the bonds to be flagged as 'green' by the Climate Bonds Initiative. If a company does not meet this criterion it cannot be included in our indices".

The bond is excluded too from the BofA Merrill Lynch Green Bond Index. "It is not flagged as green use of proceeds by Bloomberg," confirmed a senior BAML source. Leaving aside potential issues of evasion of responsibility, this has a knock-on effect: the Lyxor green bond  ETF tracks Solactive, the VanEck green bond ETF tracks S&P, the BlackRock and State Street green bond index funds track Bloomberg Barclays MSCI; the Raiffeisen fund is benchmarked against BofA Merrill Lynch.

Let's define 'material' and we'll be home and dry

You can argue that the exclusions provide useful information to the market around impact thresholds, which future issuers can capitalise on. You can also argue that the banks should have been aware of the market's sensibilities around green intensity and tweaked the structure BEFORE the deal printed.

Keith MullinBut that doesn't get us around the elephant in the room: the lack of clarity around what green is. Investors should be able to conduct due diligence based on clear rules. Borrowers should know where minimum impact thresholds are so they can decide upfront what shade of green they can/want to achieve, or fund green/greening projects away from GB.

"We could have looked at other financing options but we issued green bonds. Not because we wanted to be a part of a list but because energy efficiency was the goal," a Repsol spokesman said. "We consider the bonds are worthy [of the green label] but if not their value to us lies in their purpose."

Lack of clarity will potentially put 'brown' companies off the green bond market, to its detriment, as argued recently by Citi's green bond head Phil Brown.

CBI's Kidney hopes it will instead dissuade companies from inadequate ambition. I guess we'll see. He says he welcomes bonds from such companies – but only if the assets and projects they finance make a material contribution to addressing climate change.

Which perfectly encapsulates the issue: let's define 'material' and we'll be home and dry.

Keith Mullin is former editor-at-large of IFR and founder of KM Capital Markets