As of the beginning of May 2020, the coronavirus pandemic continues to ravage large parts of the globe. Several countries, which have been under various degrees of lockdowns, are taking tentative steps to reopen either partially or completely. Despite warnings from the World Health Organization (WHO) and the scientific community on early reopening of countries, governments are keen to ease lockdown restrictions to resume economic activity at the earliest. Stimulus plans worth trillions of dollars have been announced to kickstart shuttered economies.
While the world battles one emergency, there appears to be a real danger that two other emergencies — climate change and inequality — will be put on the back-burner. However, environmentalists, climate change experts and even lawmakers are viewing this as a momentous opportunity to deal with these emergencies simultaneously by adopting ‘green stimulus’ plans.’ The World Bank has previously defined green stimulus as “short-run fiscal stimuli that also serve a ‘green’ or environmental purpose in a situation of ‘crisis’ characterized by temporary under-employment.”
In March 2020, climate and social policy experts belonging to academia and civil society published an open letter to members of the US Congress highlighting the dangers posed by the combined impact of the three crises. There are serious concerns that addressing only one of these problems in isolation will negatively impact the other two. Green stimulus plans can be effective tools targeting all three problems concurrently.
The transition from ‘debt’ to ‘green debt’ has been a slow one. With the coronavirus pandemic necessitating record stimulus packages, the opportunity is ripe to make a gradual switch to ‘green debt’ globally. One way of achieving this is by increasing green bond issuances.
Green bonds, also called climate bonds, are fixed income financial instruments like other bonds; however, they can fund only those projects which benefit the environment or have a positive climate impact. They can be issued by companies, organizations or governments. The European Investment Bank (EIB) is credited with launching the world’s first green bond — named a Climate Awareness Bond (CAB) — in July 2007. The World Bank issued its first ever green bond in November 2008, while Poland became the first nation to issue a sovereign green bond in December 2016.
Although green bond issuances have picked up pace since 2007, cumulative green bonds issued and outstanding till early April 2020 had reached only $810 billion and $770 billion, respectively. This is less than 1% of the total global bond market of $115 trillion as of mid-2019. While government bonds make up a majority of the total bond market, only 12 governments have launched sovereign green bonds with a total issue amount of nearly $60 billion (US dollar equivalent).
Despite the coronavirus pandemic, several countries plan to issue sovereign green bonds in 2020, prominent among them being Germany, Italy, Spain, Denmark and Sweden. Germany’s commitment to go ahead with its green bond issuance is “likely to act as a reference point for other issuers.” As governments struggle to finance massive stimulus packages to restart economic activity, the issuance of green bonds may present a new fiscal opportunity to deal with converging issues — the health & socioeconomic impacts of coronavirus, and meeting commitments under climate change agreements.
“As many major central banks seem to have exhausted their ability to stimulate growth through monetary easing, developed market countries will likely embark on new fiscal easing — and it’s possible that green bond issuance is part of this,” suggests Quentin Fitzsimmons, portfolio manager and member of the global fixed income investment team at T. Rowe Price.
British Conservative Member of Parliament Gareth Mark Davies advocates a “green infrastructure revolution” instead of the “infrastructure revolution” announced in the United Kingdom’s March 2020 budget. His opinion is that as recovery from the coronavirus outbreak takes place, the country should issue a sovereign green bond which will not only boost its economy but also help in meeting the target of becoming a net zero emissions nation by 2050.
A key challenge facing the development of a robust green bond market is the lack of standards and guidelines regarding the definition of ‘green’ activities. This increases bond transaction costs significantly since investors need to undertake due diligence to evaluate the green credentials of underlying projects. A limited pipeline of reliable green projects further hampers the growth of green bond issuances.
Lack of standards exposes investors to the risk of greenwashing — a practice whereby bonds are labeled as ‘green’ but the proceeds are allocated to assets whose environmental benefits are unsubstantiated or which have a minimal climate impact. China, one of the leading green bond issuers globally, drew criticism for issuing green bonds which backed ‘clean coal’ projects. Global asset management company Insight Investment analyzed 70 green bonds in 2019 and found that 15% did not meet the minimum criteria comprising the issuers’ ESG performance, green bond framework, and quantitative impact.
In many cases, information on the ‘greenness’ of bonds is available only in the prospectus; however, there is little transparency on how the funds are being used post issuance. Some companies, which are unwilling to disclose where the proceeds are being spent, have replaced their green bond programs with new, often controversial formats. An example is Italian multinational energy company Enel SpA, a regular issuer of corporate green bonds, which switched to a new bond format linked to its sustainable development goals (SDGs).
Dedicated green investors have criticized SDG-linked bonds on the grounds that they contravene fundamental principles related to accountability and transparency. They feel that without rigorous reporting standards and restrictions on the use of proceeds, issuers’ claims that bond proceeds are being used for sustainable purposes will not be credible. There are genuine concerns that generic investors will dilute the true intent of the green bond market by investing in a wider array of ‘gray-area’ investments to meet their Environmental, Social and Governance (ESG) targets.
Limited green project pipelines and lack of clarity regarding potential projects which can be financed through green bond issuances are further hindrances to generating interest among investors and private sector sponsors. Moreover, the transition from non-green to green activities can be complex. According to Christa Clapp, Research Director at Center for International Climate and Environmental Research (CICERO), companies and industries without a strong environmental track record will find it challenging to tap into the green bond market.
Governments must set precedents to make green bonds an attractive option for investors. They can also follow the lead of countries that are using innovative strategies to promote green borrowings.
According to the International Energy Agency (IEA), “this situation is a test of governments and companies’ commitment to clean energy transitions.” IEA analysis has shown that “governments directly or indirectly drive more than 70% of global energy investments. They have a historic opportunity today to steer those investments onto a more sustainable path.” The development, deployment and integration of clean energy technologies in stimulus spending will transform energy infrastructure along with boosting economic growth.
Given the volatility in financial markets as a result of the coronavirus pandemic, investors will be keen to invest in safe asset classes. Governments can encourage investments in low-carbon infrastructure through green bonds which can be issued directly by central governments or by dedicated green investment banks. The current crisis also presents a great opportunity to end subsidies to fossil fuel companies and divert the funds to clean and renewable energy projects — these projects may also serve as underlying assets for future green bond issuances.
Governments are exploring innovative strategies to overcome other challenges associated with green bond issuances, including cost effectiveness and liquidity. Another concern is that green bonds will eat into trading volumes of traditional bonds, which will increase overall borrowing costs. To address potential liquidity issues and pave the way for future sovereign green bonds, Denmark is evaluating a new bond framework whereby a green certificate will be attached to a segment of conventional bond issue. Although both parts of the bond will be auctioned together, they may trade separately in secondary markets.
Germany’s first sovereign green bond, to be issued in the second half of 2020, will have a ‘twin’ structure — a portion of the bonds sold in conventional debt auctions will be designated as green bonds with the same maturity and coupon as their conventional bond twin. However, they will be considered separate securities with their own security code (ISIN).
There appears to be high investor demand for green bonds. Implementing standardization & structured reporting and increasing the level of transparency is likely to result in significant growth of the green bond market.
In April 2020, Climate Bonds Initiative (CBI) published the results of its first ever Green Bond Treasurer Survey. 86 treasurers (or equivalent positions) from 34 countries were interviewed. 70% respondents disclosed that demand for their green bonds was higher than the demand for vanilla (non-green) bonds, while 90% respondents mentioned that the costs of funding green bonds was the same (48%) or lower (42%) than vanilla equivalents. Besides the reinforcement of sustainability commitments, respondents cited intangible benefits — broader investor base, and enhanced visibility and reputation — as motivators to enter the green bond market.
Results of the CBI survey indicate high investor demand for green financial instruments. It is likely that the demand for top-rated sovereign green debt will be even higher. Portfolio analysts expect that the stimulus programs will attract more government investment in green markets which will increase its size. Higher issuances will also allay concerns regarding the liquidity of green bonds.
Recent years have seen various interventions to increase transparency and standardization in green bond issuances. In 2014, a consortium of the world’s leading investment banks established the Green Bond Principles (GBP), a set of voluntary best practices guidelines. Ongoing monitoring and development of guidelines subsequently transitioned to an independent secretariat hosted by the International Capital Market Association (ICMA). The Climate Bonds Standard and Certification Scheme was launched by the CBI in 2010. It is a labeling scheme for bonds which has been designed to help investors and governments preference fixed-income investments for climate change solutions.
In December 2019, Nasdaq launched the Nasdaq Sustainable Bond Network (NSBN), a global, publicly available platform designed to improve transparency in the market for green, social and sustainable bonds. It is expected that the increase in transparency and reporting of structured data will boost growth in the green bond market. The European Union’s Green Bond Standard (EU-GBS) is another key initiative which will provide investors with transparency, comparability and credibility, and ensure that investment continues to grow and is directed to proper channels effectively.
“We have the solutions and there is no shortage of capital that needs to be invested in the new low-carbon economy. We need to design the future sustainable world in which to invest that capital. Above all we need audacious ambition on the part of governments, where the focus needs to move towards switching the economy sideways, from brown-to-green.” (Sean Kidney, CEO of Climate Bonds Initiative)