Green bonds: Assessing their growth and managing their pitfalls

Emblazoned across the title of an article within The Wall Street International magazines are the words ‘the future is green’. The next frontier within the bonds market will see efforts to minimise pollution and energy consumption, whilst taking steps towards building and participating in the circular economy. The article goes on to explain that green bonds will be responsible for helping us reach these goals. So what are green bonds? Green bonds fall under the ESG umbrella, which is a market that Linear investments has been following closely. ESG labelled bonds are a segment in capital markets that are growing quickly and the two most popular types of ESG-labelled bonds are green bonds and social bonds (European Commission). In 2020, cumulative green bond issuance surpassed €850 billion in investment globally.

Where are green bonds growing?

To date, the largest source of green bond issuers and investor demand has been Europe, Mondrian Investing Partners confirms. This has been reflected within the development of the EU Taxonomy and Green Bond Standard that has been followed closely by market participants. The European Commission further denotes that EU institutions and EU Member states account for approximately 50% of the €1.1 trillion of global ESG issuance to date.

A most notable example includes NextGenerationEU, which has been created by the European Union as a response to the pandemic, and lays the roadmap to economic recovery and building a future that is greener, more digital and more resilient (European Commission). Again, according to the European Commission; ‘NextGenerationEU and green bonds: NextGenerationEU will provide a temporary recovery instrument worth €750 billion in 2018 prices or some €800 billion in current prices’. The European Commission will finance the project on behalf of the EU and will borrow on capital markets. Borrowing is set to be concentrated between halfway through 2021 and 2026, with borrowing being repaid by 2058. The European Commission is seeking to raise 30% of funds through the issuance of green bonds. European Commission President Ursula von der Leyen voiced that the proceeds are set to be used to finance green policies.

The information above illustrates how seriously the green bond market is being taken, reflected by the actions of the European Commission. Investors are becoming more investment savvy in the ESG arena, and are looking to managers to be able to provide comparable ESG data across investment opportunities, DDQ’s and reporting. For a manager this can be challenging as there have been no fixed parameters for ESG reporting although this is now changing with the advent of SFDR.

Potential pitfalls of green bonds

Despite their growth and popularity within European markets, there are potential pitfalls when it comes to green bonds. By definition, a green bond is one whereby the proceeds of financing projects directly impact the environment in a positive light. Like other bonds, they are typically governed by concerns in relation to credit quality of the issuer, duration and liquidity. However, despite their emergence signalling a notable development for bonds, there is still no one size fits all when it comes to what constitutes being ‘green’.

This therefore makes it incredibly difficult to create a global framework. Mondrian Investing Partners writes that ‘whilst Green Bond Principals from the International Capital Market Association (ICMA) have been entered mainstream, they remain to be relatively loose due to the lack of harmonisation for green bond standards and a standardised definition that is crucial to the development of the market’.

Whilst the market is rapidly growing and the Climate Bonds Initiative (CBI) calculated their total global issuance reached USD 257 billion in 2019, signalling a 51% increase from the year before (Catena Investments), there is still work to be done when it comes to providing comprehensive and robust guidance to green bonds and their issuance. If the financial services industry wishes to embrace the opportunities that come with this capital market, standardisation must be the next step.