Green bonds are big business for climate investors

by John Stapel

The cost of transitioning from fossil fuels to clean energy seems fantastically astronomical.

Current estimates of the capital needed to decarbonize the global economy and to achieve net-zero emissions by 2050 offer some eye-watering figures. They range from a high of $9.2 trillion yearly (a McKinsey report) to a low of about $1 trillion annually (according to think tank Carbon Tracker).

So, based on those annual projections, a final price tag from now until 2050 could be anywhere between $30 trillion and $275 trillion. Consider that a BCG report fixes the cost between $100 trillion and $150 trillion. Japan estimates that Asia alone will need $40 trillion to reach net zero by 2050. And Climate Bonds Initiative predicts annual green bond issuance of $5 trillion by 2025 is required to get things moving in the right direction.

New research from Bloomberg New Energy Finance has resulted in yet another number to ponder: $114 trillion in investment in the global energy system by 2050.

This analysis was aimed at determining the investment needed to reach net zero and limit global temperature increases to no more than 1.5 degrees Celsius, and was commissioned by the Glasgow Financial Alliance for Net Zero, a coalition of banks, asset managers and insurers overseeing a combined $135 trillion of assets which, obviously, has a deeply vested interest in the findings.

The research crunched numbers from credible sources — seven scenarios from the International Energy Agency, the Intergovernmental Panel on Climate Change and the Network for Greening the Financial System. The report concludes, with a nod to the daunting scope of the financial task: "Numbers show that the decarbonization of the global economy is an undertaking with few parallels in modern history."

Whatever hypothetical price you buy into, it’s bound to be a significant number — one that seems even more daunting at a time of high inflation, rising interest rates and a looming recession.

How are such vast amounts of capital to be raised? One answer is through green bonds, a variation of the fixed-income debt instrument historically used by governments and corporations to borrow large amounts of capital. Bonds are the default choice to raise money that dwarfs the ability of banks to lend. Plus, public debt markets spread the risk, as many individual investors engage as lenders, rather than one or more institutions. A green bond is a fixed income instrument specifically earmarked to raise money for climate and environmental projects

Bonds are the default choice to raise money that dwarfs the ability of banks to lend.

Currently, there’s a gold rush of inflows to green bonds of various types. The first green bond was issued in 2008, a AAA-rated issuance by the European Investment Bank and World Bank. Between 2014 and 2016, the global market began to grow exponentially; it has reached record highs each year since.

To date, the global green bonds market cumulative issuance has reached almost $2 trillion; so far in 2022, the total is $313 billion. One forward-looking projection based on inflows data comes from Moody’s, which has estimated a $1 trillion market in global sustainable debt issuance for this year. Those figures begin to approach the low end of estimated amounts that have been called for to support the transition, and they are still increasing, despite the tight economic conditions forecast for the 12 months.

What’s more, the Inflation Reduction Act looks to turbocharge the green bond market in the U.S. The $369 billion act provides tax credits, incentives and other financial support sure to stimulate funding. Stephen Liberatore, head of ESG/impact for global fixed income at global investment manager Nuveen, said, speaking at the Environmental Finance ESG — Fixed Income in the Americas conference: "Hopefully this act creates a catalytic effect in a variety of ways." 

Anjuli Pandit, head of sustainable bonds, EMEA and Americas, HSBC, agreed. "This is going to stimulate a great amount of spend towards clean energy and transport. It’s a catalyst for revolutionizing the way in which capital is going to have to flow and support a mass greening of the economy. A lot will come from large companies expanding the projects they are doing, so they will do large bonds to help finance these projects, which they will link to green labels and green financing."

There are, however, three issues that cloud this encouragingly bright picture of investing as a means of addressing climate change:

  1. Definitions: How to accurately describe the various, newly minted products? The basic green bond designation has expanded to include climate bonds and sustainability bonds, terms often used interchangeably but which denote instruments that are not identical in their details — although they may overlap. While all green bonds are a form of debt financing for an environmental project, the specifics of each differ based on its issuer and what the proceeds are used for. Sustainability bonds are used to finance a combination of green and social projects, and to allocate their proceeds accordingly. They align with the four core components of the International Capital Market Association, Green Bonds Principles and Social Bonds principles.

    Another recent is sustainability-linked bonds, which have raised the ante by promising higher returns if the issuer does not meet certain climate goals. The question of definition then, boils down to actual targets, stated purpose and distribution of proceeds for any given bond.

    In one recent example, investors bought into $589 million of sustainability-linked bonds issued by Chanel. But it turned out that the company, which set its own objectives to reduce Scope 3 (indirect) emissions by 10 percent by 2030, had already dropped its score by 21 percent below the baseline set forth in the new bond. Chanel later said that it was still "finalizing 2019 data" when the bond was sold; "in other words" reports Bloomberg, "they didn’t know that the target was already achieved."

    The other reason for this discrepancy between an aspirational goal and actual metrics: market pressure. Demand for such apparently quantifiable, targeted bonds exceeds the amount on offer by two to five times. The perceived value of "green" in the market is so high that investors are chasing the reputational "halo" from mission-specific bonds based on the most basic of information when much more transparency about much more challenging goals seems called for.

    Who’s setting targets for the variations of green and sustainability bonds, and how are they measured? The answer today is the issuer. Not surprisingly, the self-described targets are not always the most robust.

  2. Metrics and measurements: Who’s setting targets for the variations of green and sustainability bonds, and how are they measured? The answer today is the issuer. Not surprisingly, the self-described targets are not always the most robust.

    This question is particularly acute for the new, sustainability-linked bonds, as both penalties and rewards are pegged directly to performance. A Bloomberg News analysis of more than 100 sustainability-linked bonds sold by global companies to investors in Europe found that "the majority are tied to climate targets that are weak, irrelevant, or even already achieved." In the end, the issuing companies acquired cheaper financing and a green reputational "halo" without accomplishing much.

    For now, issuers of green bonds are confirming their validity by aligning with the Green Bond Principles, endorsed by the International Capital Market Association, to bring a transparent framework to the market as a solution. Voluntary, yes, but a promising effort to hold issuers accountable. Climate Bonds Initiative also offers a standardized framework and certification for various bond types. 

  3. Greenwashing: Do green bonds actually achieve the beneficial outcomes they promise? So far, the answer is a mixed one. "The changes are often less than meets the eye," concludes one takedown, criticizing a lack of transparency and goals that are too vague, too lax.

As green instruments have proliferated in the market to meet the demands of investors, so have questions about efficacy. Debates are raging about points one (definitions and taxonomies) and two (metrics and measurements) with the intent of calling out greenwashing and certifying best practices. Should frameworks be voluntary or mandatory? Can standard goals be set and adhered to? The answers are a work-in-progress.

These are still early days for green bonds, in general, and for newer products such as sustainability-linked bonds, in particular. Of the latter, Lupin Rhman, ESG integration specialist for Pacific Investment Management Co., one of the world’s largest bond investors, said, "This is a very, very young market. Two and a half years is nothing in terms of the history of investing, so this market is still finding itself."

As the green bond market matures, the promise that it can deliver the financing for an historic global economic shift beckons as an achievable goal. That would be good news for investors and for the climate-change stressed planet.

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