Green bond issuance is growing across markets
The disruption caused by the COVID-19 pandemic has affected virtually every corner of the financial markets around the world. But one particular segment — the market for green bonds, or debt earmarked for specific environmental projects — has held up better than the broader investment-grade corporate market, in large part because it is less weighted toward cyclical sectors, such as oil and gas.
But there’s another important corollary of the pandemic bolstering the green bond market: a heightened level of investors’ attention and sensitivity toward social and environmental issues. A sensitivity that could represent the beginning of a long-lasting trend that may positively impact the market for green bond investing for years to come.
Underscoring this sentiment, demand for this nascent bond asset class has been robust during the pandemic. As of the end of April, more than $50 billion of green bonds have been issued, including $16.2 billion sold in April, the strongest month of the year, according to the Climate Bond Initiative.
Beyond their usefulness as a defensive bet during uncertain times, the global pandemic could now be a catalyst to convince the wider community of investors that it’s good business to use green bonds to address our ongoing climate change challenges. A growing number of leaders want the economic recovery from the crisis to be powered by green investments: Germany and Britain have called for a “green recovery” and a group of 68 large companies (including our parent, the insurer Allianz) are urging politicians to deploy their fiscal stimulus in ways that can advance a more ambitious climate policy.
As much as $3.5 trillion of investment will be needed every year through 2050 to finance the clean energy infrastructure needed to restrain climate change, according to the Intergovernmental Panel on Climate Change. That significant capital infusion will require public-private partnerships as the private sector raises and deploys capital for the transition.
What the green bond market still needs, however, is the development of clear regulations — a process that is already underway. European Union regulators are working this year to create a set of universal green bond standards that will be vital to the maturation of a market that to date has been constrained by a lack of legal standards about what makes a bond “green.”
Clear regulations are needed in part because the young market has had a number of controversies over what constitutes “green.” Some examples: In 2014, GDF Suez (later rebranded Engie) drew protests when it issued €2.5 billion of green bonds to finance Brazil’s controversial Jirau Dam. There was heated debate over the People’s Bank of China’s rules for the acceptable use of green bond proceeds, which includes “clean coal” technologies. And last year, Teekay Shuttle Tankers struggled to generate sufficient demand for a green bond to fund fuel-efficient oil tankers, as some investors “balked at the notion that a company specializing in oil tankers can qualify for eco-friendly financing.”
Thankfully, such controversies have been contained, perhaps because they signal to potential issuers the reputational damage that can follow for any company that tries to skirt the rules.
Today, the de facto standard for rules is the International Capital Markets Association’s Green Bond Principles (GBP). The GBP uses four criteria to define green bonds: proceeds must make a positive environmental benefit; issuers must clearly communicate how they select projects; the use of proceeds must be tracked; and issuers must report the allocation of proceeds and their impact. However, these voluntary standards lack specificity.
The EU is leading that effort to formalize regulations. The first set of rules, called the Green Bond Standard, building on the GBP, was planned for 2020. A second — a 414-page taxonomy that will set definitions for sustainable activities or projects — was expected to be in place by 2022. Both deadlines could now be delayed, but these rules ultimately should eliminate any uncertainty about how proceeds can be used and how issuers should manage the green bond designation process.
Currently, most investors house green bonds in their core fixed-income allocations, and benchmark these investments against the Bloomberg Barclays US Aggregate Bond Index. This makes sense, since today green bonds essentially mirror standard bond issues in terms of price and liquidity. Both green and standard bonds are priced in line with the issuer’s credit rating. Once formal rules are in place, bond issuers will be able to develop and add specific “green” covenants that will place restrictions on the use of proceeds and will make other “green” criteria legally binding.
To be sure, the market is still in its infancy. Issuers sold $257 billion of green bonds in 2019, bringing the global market total to more than $760 billion, according to the Climate Bond Initiative. The group projected that $350 billion of green bonds would be issued in 2020. Even if the market falls short of that new high this year as a result of broader volatility, demand growth should accelerate once the crisis subsides, as governments and companies finance the transition with green bonds.
But stronger covenants should attract more issuers, who will no longer have to worry about ambiguity regarding the use of proceeds. Today, green bonds are issued most often by companies in specific sectors, such as utilities, transportation and banking (in the U.S., municipalities are the leading issuers). That issuer pool began to diversify in 2019 with the entrance of new companies from the industrial sector. Formal green bond laws and the resulting bond covenants should accelerate that process dramatically, attracting issuers and creating supply that will absorb the huge demand from investors globally.
The resulting, expanded green bond marketplace could become a critical mechanism for raising the trillions of dollars needed to finance the global transition to a low-carbon economy. Moving from a useful defensive bet today, to a form of offense tomorrow.
Julien Bras is portfolio manager of Allianz Global Investors’ Green Bond strategy, based in Paris.