It could be time for investors to give the green light to green bonds. Kate Brett and Christina Teague report
There is a growing awareness of the impact that climate change is having on our world. Increasingly, investors are seeking to understand how this process will affect their investment portfolios. To do so, they are using scenario analysis to identify future risks and opportunities.
More than two centuries of economic development has been underpinned by access to cheap fossil fuels. However, global policymakers have signalled their strong intent to lower greenhouse gas emissions. The most significant development in this area was the recent signing of the Paris Agreement, as confirmed at the December 2015 UN Climate Change Conference (known as ‘COP21’).
The goals agreed at the conference involve keeping emissions low enough to contain global temperature rises to within 2˚C this century, relative to pre-industrial levels. However, while a shift toward a low-carbon economy has begun, given that the world has already surpassed 1˚C of warming, it is anticipated that the policy response to mitigating climate risks will become increasingly urgent in the coming years.
Investors will increasingly identify projects related to the shift to a low-carbon economy that require financing.
In other words, policy action is expected to drive investor action once again and further increase the demand for products such as green bonds.
Green bonds, also known as climate bonds, are a form of debt expected to play a significant role within this growth. Nearly a decade after the first green bond was launched by the European Investment Bank (EIB) – the Climate Awareness Bond in 2007 – the green bond market has developed from its nascent form into an area that large-scale investors are pursuing more actively.
As with any developing area of the market, many questions remain. However, there is potential for significant and rapid growth. Historical barriers, including standardisation, supply and market scale, are beginning to be overcome – and we might just be seeing the green shoots of something much grander. The meaning of green
One of the barriers that has held back investors is a degree of scepticism that ‘green’ actually means ‘green’. Investors are sensitive to self-labelling and are increasingly aware of products failing to behave as expected in terms of delivering a measurable and meaningful impact, be it environmental or social. Tales of ‘greenwashing’ abound, and, while there remains no universally agreed standard or definition of a green bond, as the market has developed, the concept has become more standardised.
The Green Bond Principles were launched in 2014 to help address this concern. The Green Bond Principles
Initially published in January 2014, and updated in June 2016, the Green Bond Principles are voluntary process guidelines that recommend transparency and disclosure, and are intended for broad use by the variety of actors participating in the market. The principles are designed to provide the information needed to increase capital allocation to environmentally sustainable purposes, without any single arbiter, and are built around four core components:
- A security’s use of proceeds should aim to address a key area of concern, such as climate change, natural resources depletion, loss of biodiversity or pollution control
- The issuer must outline the decision-making process for determining eligible projects or investments
- A formal process to ringfence net proceeds must be disclosed
- The issuer must report on eligible projects at issuance, or state its commitment to report within a year of issuance.
Two years on, more than 30 investors, 25 issuers and 55 underwriters have become registered members of the Green Bond Principles.
In addition to the Green Bond Principles, the World Bank, the Climate Bonds Initiative and environmental, social and governance (ESG) data providers, such as Sustainalytics, are developing recognisable standards for the industry and providing independent verification regarding the environmental impact.
Ultimately, investors and their advisers will need to be satisfied that investments meet their environmental requirements. Nonetheless, investors should be increasingly confident the industry is heading in the right direction.
Kate Brett is principal, responsible investment, Mercer
Christina Teague FIA is senior investment analyst, Mercer