Green bonds explained
Exploring debt securities used to finance green projects and assets.
27 July 2020.
Recently our Chief Investment Officer, James Cook, attended a Green Bond Boot Camp hosted by the Climate Bond Initiative. This event aimed to bring clarity on the certification process and merits of Green Bonds. The growing prevalence of eco-conscious financial tools means understanding the role they can play in a climate-conscious future is becoming increasingly pertinent.
What makes a Green Bond, green?
Green Bonds, as defined by the Climate Bond Initiative, is a debt security issued by financial, corporate or public entities where the proceeds are used to finance green projects and assets. Similar to standard bonds in structure and credit rating, Green Bonds have the “bonus feature” of being environmentally conscious and climate active.
Since the first Green Bond established by the European Investment Bank in 2007, their presence in the market has expanded to make up US$168 billion issued in 2018. A relatively small amount when compared to the global bond market of US$100 trillion, but a considerable figure nonetheless (Climate Bonds Initiative, 2020). This growth has created a need for a common language to be defined and a consistent certification process applied. The Climate Bond Standard caters to this need, in providing an identifying tool for investors and ensuring accountability to green promises.
Greater transparency and consistency needed
The Climate Bond Standard’s principles for labelling and external review process is imperative to identifying bona fide green bonds. Additionally, Cook contends “the process by which the bonds are regularly reviewed must be recertified annually and is the key to maintaining transparency and accountability.”
Currently there are no restrictions to ensuring a Green Bond is in fact legitimately environmentally sound. The term “Greenwashing” has been coined to describe unsubstantiated claims to mislead a product’s sustainability contribution. Any issuer can call a bond “green,” thereby making the universal certification process crucial for investors to identify the outcomes of what they are buying.
The Green Bond market is inherently linked with the United Nations Sustainable Development Goals (SDG). Where arguably all 17 goals rely on climate mitigation, various types of Green Bonds can contribute to SDG 6 Clean water and sanitation, SDG 7 Affordable and clean energy, SDG 9 Industry, innovation and infrastructure, SDG 11 Sustainable Cities and Communities, and of course SDG 13 Climate action (Climate Bonds Initiative, 2020). Green Bonds have the ability to create a bridge between consumers and participating in achieving these goals by 2030.
“If the targets of the SDG’s are to be met, it needs to be coupled with the participation of the private sector,” says Cook.
Are Green Bonds ethical?
The Climate Bond Standard Certification alone, however, is not enough to consider a bond as comprehensively ethical. This program is indifferent to the ethical standing of the issuer, so long as the bond itself passes their labelling process in providing environmentally beneficial outcomes.
“At U Ethical we believe in confirming the issuer also passes our ethical screening process,” Cook maintains.
“At the end of the day they are benefiting from issuing that bond, and we need to be certain we are comfortable with the issuer’s own core activities.”
Australian Green Bond market still in infancy
Green bonds at present are mainly issued in Europe and hold a very small presence in Australia. A contributing factor for this is the lack of constructive government policy on renewables and environmental sustainability which would encourage green bonds. There are fewer green projects funded by debt which results in less green bond issuance.
This should not dishearten the eco-savvy investor, as renewable energy is growing in acceptance and popularity, evident by the $38 billion invested in Australia’s first Renewable Energy Zone in New South Wales (Renew Economy, 2020). Consequently, there is likely to be a commensurate increase in capital raising which can only extend the depth and diversity across available issuance to help establish a liquid and mature asset class in its own right.
Cook said “it is pleasing to note the rising acceptance of green and social bonds – almost too much as their popularity has resulted in most issues being very well bid, which is ultimately very encouraging for the sector.” The scarcity of Green Bonds has resulted in fully priced paper when compared to other debt securities with larger institutions taking the lion's share, which can make it difficult for boutique investors such as U Ethical. Despite the premium Green Bonds attract, the market seems hungry for more, with investors willing to compete to buy the security. A trend which has been encouraging for companies to issue green bonds to take advantage of this premium.
Current opportunities limited but looking toward growth
U Ethical believes green bonds is an exciting sector that has been gaining traction over the last decade and we are keenly looking for opportunities to bring our investors value as well as make a positive impact on the environment. Green bonds offer a worthwhile instrument for funding renewables, a space that will surely grow in the coming years as climate action becomes ever more at the forefront of our minds.
U Ethical has also been working closely with initiatives to tackle the chronic shortage of social and affordable housing which Cook believes “offers fantastic scope to deliver investors with an opportunity to secure reliable investment opportunities while capturing a real and tangible positive social impact – a pursuit central to U Ethical’s ethos and approach.”
It is up to the broader investment community to embrace green bonds as an important step in moving towards sustainable carbon emission targets and to encourage companies and governments to move accordingly. The rising issuance and acceptance of green and social bonds is certainly a step in the right direction.
The commentary reflects U Ethical’s position at the time of publication and is subject to change. U Ethical reserves the right to make any adjustments to the investment strategy or outlook for all products at any time to reflect major disruptions or changes in the financial markets, as allowed by the relevant governing documents, Product Disclosure Statement, Information Memorandum, or Offer Documents.
The information provided is general information only. It does not constitute financial, tax or legal advice or an offer or solicitation to subscribe for units / debentures in any U Ethical Fund of which U Ethical is the Manager, Administrator, Issuer, Trustee or Responsible Entity. This information has been prepared without taking account of your personal objectives, financial situation or needs. Before acting on the information or deciding whether to acquire or hold a product, you should consider the appropriateness of the information based on your own objectives, financial situation or needs or consult a professional adviser.
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