By Laura Nishikawa
Like every other year, 2014 was a year of surprises in markets. For some asset classes, the year saw large price falls: for example, many investors in oil and in some emerging market currencies witnessed substantial corrections in the latter part of the year. Equity investors will, as a whole, have seen better returns, but with large disparities between sectors and geographic locations.
One asset class which has lately seen consistent interest from institutional investors, and growing appetite from issuers, is green bonds. Green bonds are fixed income securities issued to fund projects and initiatives which yield an environmental benefit for the issuer, or for society in general.
In three years, the market for green bonds has gone from a niche investment, where low yielding instruments, issued by highly-rated development banks and supranational issuers were pitched for a relatively small audience; to a burgeoning asset class, issued by utilities, corporates, REITs, banks, local governments, agencies, and even ABS, to a broader institutional investor base, comprising of both dedicated “green” investment and broader-based fund managers and pension funds.
So far, according to the Climate Bonds Initiative1, a not-for profit organisation that seeks to utilise the power and influence of debt capital markets to effect global climate change, $34.84bn of green bonds were issued in 2014. Twelve months earlier, the total for the 2013 calendar year was $10.98bn.
Institutional investors continued to be attracted to green bonds in the context of their mandates.
However, while the investment environment for green bonds appears benign, there remain two big challenges for institutional investors.
The first is measuring performance. Until very recently, measuring the performance of the green bond market has been challenging.
The second area of uncertainty is whether the investments are actually green: institutional investors who are committing to green bonds for reasons of social responsibility need an independent and objective assessment of securities’ “greenness.”
In particular, institutional investors need to know that that proceeds are used for appropriate projects; that the evaluation of those projects is transparent; the proceeds are managed effectively; and that there is a clear reporting mechanism. Barclays MSCI Green Bond indexes are designed to help institutional investors address this challenge.
Eligibility for inclusion depends on the index in question but each index is designed with the aim of offering users the transparency required for them to accurately measure this nascent but emerging fixed income asset class.
Each offers independent “green” evaluation of bonds by MSCI ESG Research’s Environmental, Social and Governmental research team to identify green bonds from the broader universe of self-labelled green securities.
To be classified as a green bond, a security’s use of proceeds must fall within at least one of five eligible environmental categories: alternative energy, energy efficiency, pollution prevention and control sustainable water and green building. Ninety percent of an issuer’s activities must fall within one or more of the eligible MSCI categories.
Like the very idea of “green”, green bonds have been a weakly standardised concept, requiring objectivity and interpretation about what is and isn’t a climate-related instrument. But the appetite for the instruments, the greater investment consensus established with the Green Bond Principles in January last year, and the growing availability of indexes, serve to provide the market with transparent and cohesive methodologies designed to identify and represent the performance of green bonds.
The Climate Bonds Initiative, estimates that more than $100bn of green bonds will be issued in 2015. This potential growth in scale and diversity, and the new tools to help investors evaluate these relatively new securities, may mean that 2015 becomes the year that green bonds become mainstream.
Laura Nishikawa is head of fixed income ESG research at MSCI
1 Source: Climate Bonds Initiative: http://www.climatebonds.net/
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