The Name's Bond: Green Bond

In a society where the newest crazes are metal straws to save the turtles and dazzling pieces of jewellery made out of callous animal traps, surely there must be something within the financial world to spur on green finance and promote a sustainable future. There is - just as the likes of Daniel Craig, Pierce Brosnan and Sean Connery manage to save the world, supposedly so will green bonds.

Green bonds

Green bonds are a form of issued debt which specifically raise money for environmental projects. They typically come with incentives (e.g. tax exemptions) to enhance their attractiveness to investors. As the environment becomes more of a salient issue in society today, pressures to follow ESG leadership have escalated, encouraging the growth of the green bond market. This is because ‘green bonds often serve as an entry point for issuers and investors interested in using their investments to overcome global challenges as highlighted by the 17 UN Sustainable Development Goals’ (Hua, 2019). With companies facing increasing pressures to adhere to ESG criteria, whether it be out of a genuine commitment to sustainability or merely a façade to acquire a more favourable outlook to new investors remains to be seen. However, whatever the motive, it has massively aided the growth of the green bond market as demonstrated by the ICE BAML Green Bond index which increased from $55bn in 2015 to $345bn in 2019. With cut-throat economists the sole motivation for investment is profit margin, which is why many investors disregard green investments – viewing anything ‘green’ as a low-yielding bubble ready to burst. What they fail to acknowledge is not only have ESG investments provided a higher return than other financial products during the current health pandemic, with ESG indices holding ‘up better through the downturn than their broad-market counterparts’ (Nauman, 2020), they also act as a warning to investors. This is because the ESG components act as a determinant of companies’ future financial performance, enabling investors to identify companies which pose greater financial risks due to their environmental, social or governing practices. So why, with such large benefits, has the green bond market not grown quicker?

One significant drawback of green bonds is the limitation and exclusion of smaller issuers. The biggest obstacle being that smaller corporations struggle to identify sufficient expenditures on business activities related to sustainability. In order for a bond to be considered attractive to investors the risk has to be well distributed, meaning bonds generally need to be issued at a minimum aggregate principal amount of over $250 million. This ‘benchmark’ is only continuing to increase. The minimum in global bond markets for EUR is 500m with investors requesting €1bn and larger given that the ECB can buy 33% of outstanding bonds, even 50% for supranationals like ESM or EIB, through their QE programmes (PSPP and PEPP). This massively hinders the expansion of the green bond market, capping and limiting the growth of sustainable finance as it excludes many potential issuers. This, albeit a very large problem, is not the only issue. Green bonds also encounter the problem of ‘greenwashing.’ Simply put, this term is used for when corporations use green concepts as a PR marketing scheme in order to obtain a more favourable public image, as well as to avoid coming under scrutiny for their lack of sustainable procedures. Take BP’s recent commitment to the UN’s ’Race to Zero’ initiative, could it be a way to disguise their not-so-ethical practices? Perhaps it’s a way to disassociate themselves from the Deepwater Horizon oil spill of 2010.

Sustainability-linked bonds

Sustainability-linked bonds however manage to overcome these issues of exclusion and greenwashing. These are bonds in which the proceeds are applied to finance a combination of green and social projects. This means that they not only meet the environmental aspect of ESG criteria but go one step beyond green bonds by fulfilling more of the ESG components. The Italian energy group ENEL issued the first successful sustainability-linked bond of $1.5 bn with a 5-year maturity and a 2.65% coupon, subject to the energy group having 55% of its installed capacity in renewable energy. If this goal isn’t reached by 2021 the coupon on the bond will increase by 25bps until the bond matures. Thus, showing sustainability-linked bonds have overcome many of the issues associated with green bonds through not only avoiding ‘greenwashing’ by requiring companies to meet certain sustainability conditions but through the expansion of the market as well. This is because they facilitate more issuer participation through linking financing to sustainability in a different way rather than restricting how the proceeds are used. Instead, they link the interest rate to sustainability. Meaning issuers with lower levels of sustainability funds are also able to enter the market, further promoting and enhancing the quality of sustainable finance. So surely corporations must be scrambling to issue these bonds? Unfortunately, no.

Whilst sustainability-linked bonds are supposedly the way forward, when ‘putting the terms “sustainable investments” alongside fixed income, investors think principally – if not entirely – of green bonds’ (Reznick, 2019). Despite green bonds posing more issues, investors and issuers rarely consider sustainability-linked bonds as an alternative due to its recent introduction, making investors wary. However, in such a fast-paced industry with a constantly evolving market this is sure to change. Perhaps in the future a better alternative will be found like the ‘green striped bond’ but for now, just as the cinematic industry is struggling to cast a new James Bond, the financial sector struggles to find a suitable alternative to save green finance.

By Prashina Harjani

References:

Green Bond Impact Report (2019) The World Bank [online]. Available at: http://pubdocs.worldbank.org/en/790081576615720375/IBRD-Green-Bond-Impact-Report-FY-2019.pdf

Nauman, Billy (2020) ‘Coronavirus is strengthening the hand of ESG investors’ (15 May 2020)

The Financial Times [online]. Available at: https://www.ft.com/content/19047cda-0648-48a9-a512-87653149026c Reznick, Mitch (2019) ‘Green bonds on the rise’ (27 November 2019)

Financial Times Adviser [online]. Available at: https://www.ftadviser.com/investments/2019/11/27/green-bonds-on-the-rise/