• Yousun Cha

CMI Explains: The Rise of Green Bonds



In the span of a decade, Green Bonds have gone from the periphery of capital markets to one of its fastest-growing segments. What are they and how have they become mainstream? Will they prove central to our green recovery, or are they just a passing fad? In this week’s CMI Explains, we take a closer look into the mounting interest in Green Bonds in advanced and emerging economies alike.


At its simplest, a bond is an IOU, where the debtor promises to pay a fixed amount to the lender repeatedly over its lifetime (this is the fixed-payment type). At the end of the period, the debtor repays the principal amount, plus any outstanding interest. Green bonds stray from the pack in that the money is not spent at the company or government’s discretion. Rather, its proceeds are earmarked for financing (or refinancing) green projects – covering things like renewables, energy efficiency, pollution prevention, fishery and forestry, protection of marine life and clean transportation to name a few.


The pilot green bond launched under the name “Climate Awareness Bond” in 2007 by the EIB (European Investment Bank) and the World Bank. Initial issuances naturally came from organisations that resemble its founding fathers – multilateral development banks that seek climate objectives. For instance, solar voltaic systems financed by the World Bank green bonds helped to electrify rural households in Mexico and Peru.


However, it is only as corporates jumped onto the green bandwagon that the market saw explosive growth. The first successful corporate issuance came from Vasakronan, a Swedish property company, in 2013 – shortly followed by climate-centric investor groups and funds who increasingly considered exposure to carbon as a risk when making investment decisions.


This corporate push was soon coupled by a political one: the instrument was seen as a solution to tackle the investment gap required to meet Paris Agreement targets (2015) as well as UN Sustainable Development Goals (2016).


The resulting growth spurt is simply astounding. In less than a decade, issuance rose from 1billion to $305.3billion (in 2020), with cumulative issuance since inception breaking the $1trillion mark according to Bloomberg BNEF. Green Bonds have expanded further to capture ESG trends, and now climate bonds come under a wider umbrella of “ESG bonds” that include social/sustainability bonds as well as the greener ones.


A natural question to ask, therefore, is what exactly counts as “green.” Is fracking green? Is nuclear power? At the moment, there is no legal definition, which meant nascent issuers had no choice but to self-proclaim their “greenness” (a famous example is Toyota in funding its low-carbon tech).


It is precisely for this reason that investors became wary of such instruments – it can provide an easy means to “greenwashing.” Greenwashing (as coined by Jay Westerveld in 1986) is the practice of channeling proceeds from green bonds towards activities that have negligible or negative environmental benefits. These refer to incidents like the issuance of a green bond by Three Gorges Crop in China, which had been routinely criticised for polluting water and damaging ecosystems. Similarly, a Madrid-based oil and gas company named Repsol issued a set of Green Bonds that were used for making their oil refineries more efficient.


Particularly in the case of governments, the link between green issuance and any additional green spending is tenuous at best. Germany’s recent dive into the market was welcomed by many yet its €12.7bn allocated to green spending implies that it isn’t financing things much beyond the scope of what it was planning already. A similar logic applies to the hype surrounding Rishi Sunak’s plan to issue UK’s first green bond this year. Unless proceeds are clearly ringfenced for green projects, it may as well be accused of ‘state-backed greenwashing’ along with others. Yet it seems as though in many countries including the UK, governments are settling for a more ‘symbolic’ significance of green issuances rather than opting for ex ante strict ringfencing procedures.


In efforts to promote its integrity, Green Bond Principles (GBP) were established by the International Capital Market Association in 2014, providing broad guidelines regarding the use of proceeds, process for project evaluation, management of proceeds and reporting. Secondary opinions from environmental organisations as well as Climate Bond Standards (CBS) currently augment the evaluation process. The most recent development has come from credit rating agencies like S&P Global and Moody’s that have launched green-evaluation services that grade bonds on a scale of “greenness.” This is a massive step up from a binary ‘green to non-green’ classification that rejects nuances and is thus welcomed by many investors.


However, as standards and methodologies become more complex, the merits of international standardisation of green bonds become clearer: for issuers, it will become relatively cheaper to prove their ‘greenness’ without the need for multiple credentials. For investors, it will become easier to evaluate and compare climate bonds when they are standardized than not. Should these hypothetical standards require stricter ringfencing on xyz projects, it may further empower them to confidently embrace this form of value-oriented investing, knowing that it does not put tokenism ahead of real impact.


Or it may even be that principles don’t really matter that much in the first place. “We don’t buy a bond because it’s green, but because the company is,” tells Tom Chinery, a corporate bond portfolio manager at Aviva Investors. This cynical bunch thinks that assessment of the bond itself is like cherry-picking the ‘clean’ parts of the business and deciding whether it fits standards. Instead, they seek to turn a more shrewd eye towards the entire profile of the issuer to see whether the remainders of the business appear coherent with what the green paper ambitiously projects. For sovereign bonds, the country’s overall ethical/sustainability metrics are increasingly coming into consideration.


Its ongoing developments aside, it is clear that green bonds will play a key role in the global recovery plans in the near future. European Commission President Ursula von der Leyen announced that it will issue more than $270 billion this year as part of its pandemic relief program – potentially doubling the green bond market. The US president-elect Joe Biden’s pandemic recovery plan, worth $1.9 trillion, also ties the distribution of funds to renewable energy targets.


Although Green Bonds currently make up around 4% of total global bond issuances, its prominence within the market will only grow into the near future. Especially with demand far outstripping supply (and therefore creating a “greenium” – a green premium), it is clear that investors are hungry for green bonds and financial resilience they provide. Its way of becoming more transparent, diverse and embedded into stimulus programmes are just a few things to watch out for in the coming year.