The changing shape of the green bond market

As growth in the green bond market shows signs of slowing, this roundtable, organised by Environmental Finance with the support of DNV GL, examines the challenges facing both issuers and investors.

Graham Cooper: The green bond market has developed rapidly in recent years, but growth has slowed after volumes trebled in 2013 and 2014. Many investors are asking for more clarity about use of proceeds and the environmental impact of the bonds. Yet, at the same time, there is no pricing differential compared with plain bonds, so there are clearly tensions in the market.

Pernille Holtedahl: I agree market growth is somewhat disappointing but, on the other hand, we do see interesting issues in terms of new currencies and regions, etc. So maybe that is another way of growing it slowly but steadily.

Doug Farquhar: I think it is natural that growth is going to slow as the market matures. For us the big challenges are engaging different parts of the market and, in the absence of regulations, keeping its integrity. There is a lot of debate around what information investors want to see in terms of the use of proceeds, the performance of the assets and standards. I think it is important not to set too rigid constraints while the market develops. We have the Climate Bond Standards and the Green Bond Principles, but what we look for in all our processes is additionality – what is beyond business as usual?

Rhys Petheram: For me, additionality is the big credibility test for the market, which we need to sort out. When you think about the purpose of the green bond market: it is to mobilise capital to address climate change. So I see a disconnect between the providers of capital, who want to do this, and the issuers who take the money but are just refinancing existing projects or doing projects that would have been done anyway.

So I am interested to hear that you do see additionality; I think the framework is there, but I have not yet seen enough additionality.

Charles Smith: I agree that mobilising green projects is the goal but, ultimately, I think it is a much larger transition process. It is about changing the way companies and entire societies think about and engage with the environment. And that is not done in a day.

I am with a development bank and, to be perfectly clear, we would have funded all our projects anyway. It is our job; it is in our mandate. But we issue green bonds to help this transition process.

Emanuela Cernoia-Russo: I agree. At Transport for London, it is extremely important for us to underline the impact of our activities on the environment and we could not have issued a green bond if it was only to fund incremental activities. So I think a transition to some stricter rules might be desirable, but a bit of freedom to invest in a project we would have done anyway – but that is beneficial for the environment – I would see as very positive.

Justin Eeles: Presumably, for some companies, there is an element of bringing forward funding by using a vehicle such as a green bond because it has a wider investor base, potentially. And, for the asset owner, the transparency of how those proceeds are going to be used, rather than just 'general corporate purposes', is beneficial.

Yo Takatsuki: I think one of the challenges is that the underlying assets that are being financed through green bonds are mostly renewable energy or energy efficiency. If we want a broader range of corporates to come to the market we need to encourage opening up the focus of projects beyond just climate change.

I think people are struggling with impact reporting. For renewable energy, it is relatively straightforward but for other types of projects the impact reporting is either not agreed or is not sufficiently established.

Pernille Holtedahl: But, surely, if you have thought about issuing a green bond you must have thought about the likely environmental benefits. You have to do a bit of homework yourself. Then I think it will be quite clear, in a number of categories, what the environmental benefits are. And then, when you get to the reporting stage, I agree that you should not overcomplicate it. But, if you want to claim that something is green, surely you must be able to quantify it somewhat?

Cathrine de Coninck Lopez: The Nordic Investment Bank, for example, said: 'We are going to invest in renewable energy and energy efficiency but also waste energy and recycling'. But their overall metric is still carbon; it is not the number of metric tonnes of waste recycled, or avoided. So I agree that there is a challenge.

Pernille Holtedahl: If I had a good, new waste technology that would enable me to reduce waste in my production, I would be very happy to quantify that, not in terms of carbon dioxide (CO2) but in terms of waste. And I would go to the market and sell that as an environmental bond.

Mark Thompson: Why would you do that as an environmental bond, rather than just any bond? It must be because, as an issuer, you think you are going to get a better price. But, as an asset owner, why should I invest in a green bond, given that I am in a fiduciary framework?

Pernille Holtedahl: Sure, you have your fiduciary responsibilities. But in addition, all else equal, you will also have some side benefits.

Mike Clark: To me the green bond market is essentially driven by a 'use of proceeds' concept. But the world of pension funds and insurance company assets that we inhabit focuses on 'alpha' and 'beta' and use-of-proceeds is not considered so much.

Mark Thompson: If I am the trustee of a pension scheme, I have to act in the best fiduciary duty of my members. So why would I pick a green bond over a non green bond if the green bond gives me less return for the same level of risk?

Emanuela Cernoia-Russo: I am also a director of the TFL pension fund and right now I have the same issue because our fiduciary duty is to maximise the return for our pensioners. But, increasingly, our members are showing interest in assets that have environmental benefits. At present the pricing of green and non-green bonds is more or less equal, but from an issuer perspective, I would like a lower price whereas, from an investor perspective, I would prefer a higher price. This is one of the tensions.

Charles Smith: Although it is more expensive to issue a green bond from a resource point of view, we issue at exactly the same level as for a generic bond. And we are happy to do so. For us, as a development bank, being green is part of our mandate and it is relatively easy for us to provide the extra resources. But, looking at the bigger market, this extra cost needs to be shared somehow.

Cathrine de Coninck Lopez: Can I come back to the point about fiduciary duty and the trade off, or perceived trade off? We would not invest in a green bond if it had worse financial characteristics than other issues, just because it was green. It is the same for our UK Social Bond Fund – we aim for social outcomes, yield and liquidity and we have very competitive returns in that portfolio and in our other funds that invest in green bonds.

Mark Thompson: So why do all your bond funds not invest in green bonds?

Cathrine de Coninck Lopez: They do.

Yo Takatsuki: Yes, green bonds are held in standard mandates. Our rates desk holds green bonds from the European Investment Bank and other major issuers as a matter of course. They look mostly at the maturity and yield initially and the green aspect is seen almost as a bonus.

Justin Eeles: For an asset owner, I see the transparency of how the proceeds of green bonds are used is analogous to having a greater focus on corporate governance in the equity market.

Responsible investing has grown on the equity side, but it has not happened in quite the same way in the bond markets. Over time, this could be an opportunity. You could end up with differential pricing if asset owners, or investors, believe that it is sensible to have transparency about how the proceeds are used. And bonds that are for 'general corporate purposes' could become cheaper because there is less disclosure.

Lionel Pernias: Green bonds can certainly be used to invest in companies that are ahead on ESG (environmental, social and governance) issues. Over the long term, as you say, you are protected against these risks. And, in terms of returns, because you are talking about fiduciary risks, that is important.

Mark Thompson: So, if I am buying a green bond, then even if I am getting a slightly lower apparent return now, I am protecting against the left tail risk further out, so you are saying that could fit into a fiduciary framework?

Justin Eeles: If, over time, you could see other benefits, in terms of the company being more sustainable, then you might accept a slightly lower return. I think it comes back to the reporting and disclosure element of green bonds – it gives you more information to help you make that decision.

Mike Clark: There may be some analogies with ESG issues, such as governance, in the equity market. But the key point about governance is that it affects the value of the entity, the security you are investing in. But in fixed income you are making the investment effectively on a use of proceeds argument, so you do not get the 'G' sort of alpha factor.

Justin Eeles: But potentially, in the medium term, you might do, if there is a greater focus on the use of proceeds.

Mike Clark: But there is the ownership issue in the equities space which does not happen, as I see it, in a use of proceeds argument to the same extent.

Part 2 of this roundtable can be read here.