How green is your bond?

23 Oct 2019

The green bond market is evolving into new areas, but, as Mark Dunne asks, are investors getting what they are paying for.

Green bonds come in many shades, even blue. They are also available in different flavours, such as sustainable, climate, social and transition. The green finance market has evolved into specialist areas to meet demand with green bond issuance expected to top $200bn next year, if not before. But is a fear of greenwashing putting some investors off using such products to build sustainable debt portfolios?

The first half of the year saw $117.8bn (£963bn) of green bond issued, a 48% improvement on the same period of 2018, yet the market has a credibility problem in some quarters.

Indeed, the market is too small. The UN forecast that $90trn needs to be invested to achieve its Sustainable Development Goals, a blueprint that it hopes will create a sustainable future.

Green bonds are a small part of the $100trn that the global bond market was worth in 2018 with the World Bank believing that there is only around $500bn outstanding in such bonds, or less than 1% of the total bond market.

Green bonds finance projects that are designed to help protect our environment. These could typically include building solar power parks and wind farms, developing cars that produce less greenhouse gas emissions or purifying water. But this is part of the problem with green bonds. They only serve one of the three pillars of the environmental, social and governance (ESG) universe.

Yet the market has come a long way since the European Investment Bank issued the inaugural green bond back in 2007. Before then, investors had few options in the fixed income space to fund the fight against climate change and had to assess the ESGmerits of conventional bonds.

The market has evolved during that time and green is not the only option for those looking to build a sustainable fixed income portfolio. We now have blue bonds, which fund ocean-based projects, and climate action bonds that help companies clean up their operations. Italian gas company Snam, for example, raised $500m earlier in the year through such a product to reduce its methane emissions.

Other options include social bonds where $14bn (£11.3bn) was raised last year to fund access to health care, education and affordable housing.

Sustainable bonds are a hybrid that fund environment and socially focused projects, with $17bn (£13.8bn) put to work through these products in 2018.

“Green bonds are just one of many different flavours,” says Scott Freedman, a fixed income manager at Newton Investment Management, adding that this could include conventional debt. “In certain instances, companies issue a pseudo-green bond in that it is specific project-focused, but they don’t call it ause the name green bond.”


The reporting and verification needed before launching a green bond increases the cost of such an issuance. So choosing to sell a conventional bond instead of debt that is labelled green could mean that more of the proceeds are spent on the intended project.

“It can be costly and time-consuming, and which is probably why some issuers don’t issue green bonds,” Freedman says. “They have to go through extra regulation, pay a third-party agency to rate their bonds, commit to ongoing reporting and ensure that they have access to capital elsewhere.”

On the investor side of the deal, one of the biggest issues is the risk of greenwashing. The lack of a universal definition of what makes a green bond a green bond is a wellpublicised problem. Indeed, in 2018 the Climate Bond Initiative identified almost $25bn (£20.3bn) worth of green bonds that it believes were green in name only.

“People are looking for these products, but we are not entirely sure that they are what they say they are,” says Anna Rudgard, consultant in fixed income manager research Aon.

Inconsistent ESG ranking systems add to the problem. You need to do your homework and look at what makes the debt green, as Freedman discovered when he examined a bond that a German wind farm turbine specialist was issuing. “Apart from saying “green” on the prospectus, nothing was mentioned in the presentation about the greenness of the bond,” he says. “It was just ticking a box-ticking exercise and that company has since defaulted.”

So the credit analysis is just as important as assessing the green credentials of a bond, because you still run the risk of buying something that could be obsolete before the debt is repaid.

If you find a bond that looks as if it will do what it says on the tin, and you are happy with its credit profile, the next challenge is to confident that the proceeds of a green product will be used as advertised in the sales pitch.

We are managing our clients’ capital and we are not mandated to accept a lower return just because it is a green bond.

Scott Freedman, Newton Investment Management

Mexico City Airport Trust, for example, issued a green bond to build an airport, but a new government halted its construction. What happened to the proceeds of the bond? Have they been used for a green purpose?

“We need to be comfortable that green bond issuers are doing what they say they will do with the proceeds,” Rudgard adds. The good news is that various institutions and organisations are working on improving standards and setting definitions.

The European Commission has tabled a definition that it hopes will bring clarity throughout the EU, while the ICMA Green Bond Principles were published in 2014 to strengthen the integrity of the market. Here the definition of a green bond is articulated through four principles: use of proceeds, project evaluation and selection, management of proceeds and reporting. As welcome as these principles are, they are not legally enforceable, so “it is difficult to know concretely that every green bond is a green bond”, Rudgard says.

Other criticisms include that the principles do not define what a green asset is. It also does not provide guidance on if energy efficiency projects should be included. Not everyone would agree with coal-fired power plants issuing a green bond to implement energy-efficient measures.

People are looking for these products, but we are not entirely sure that they are what they say they are

Anna Rudgard, Aon

One of the most interesting developments in the market is a club of central banks working to integrate ESG factors into their operations. They are also setting a roadmap to expand green lending.

“The market is going through a process of innovation,” says Felipe Gordillo at BNP Paribas Asset Management, especially when it comes to establishing a definition of sustainable debt.

The improvements that Freedman would like to see include the proceeds of such assets being ringfenced and compulsory project reporting.

The lack of transparency and a universal definition means that Candriam is yet to launch a pure green bond fund. “There are a few things that need to be done before we can embrace green bonds,” David Czupryna, head of ESG client portfolio management at Candriam, says, adding that existing standards leave investors exposed to greenwashing.

With this in mind he says that green bonds are not the best way of building a sustainable bond portfolio. “They are part of it, for sure, but the green bond market is not diversified enough yet to be the base for a global fixed income portfolio.”

The green debt market is driven by sovereigns and quasi-sovereigns with only a few sectors active in this market. Although more than 40 countries have green bond as part of their debt pile, issuance is dominated by a small group, including China, France and the US.

This lack of diversity is why Candriam is yet to establish a pure green bond fund. “We want to tap issuers who are not issuing green bonds,” Czupryna says.

For pharmaceuticals, media companies or telecommunication groups issuing green bonds is not straight forward.

This is not the only reason. Czupryna points to a need for standards to improve before they embrace the market, but he concedes that things look bright in this area. “The market is there. It is moving in the right direction,” Czupryna says.


Concerns with green bonds go beyond if they are green enough. Green bonds are not necessarily more legally secure and are not more senior in the capital structure as a conventional bond issued by the same company, but you are taking the same risks. Along with that, they are trading at tighter levels to their comparative bonds. “You are paying a green premium for them,” Rudgard says.

Indeed, telecommunications giant Verizon paid 3.9% for the $1bn (£812.3bn) green bond it issued earlier this year. This was slightly lower than the yields offered on its conventional debt, a result of high demand and not enough supply for sustainable debt products.

Freedman adds that no matter what project a green bond is funding, there needs to be a strong financial case when deciding to invest. “We are managing our clients’ capital and we are not mandated to accept a lower return just because it is a green bond. “Overtime, green bonds will probably trade at a slightly tighter spread,” he says. “This is probably due to there not being many green-labelled bonds around, so there is a scarcity value.”

So in a risk-off scenario such debt should perform better than mainstream bonds because there will perhaps not be as many sellers.

They are part of it, for sure, but the green bond market is not diversified enough yet to be the base for a global fixed income portfolio.

David Czupryna, Candriam

Jan Willem de Moor, a senior credit portfolio manager at Robeco, says that green bonds benefit in the secondary market from growing investor interest. “This means that green bonds often perform well after new issuance. That also implies that after a while green bonds can become expensive, which can be a reason for us to sell again.”

When it comes to the cost companies are paying to borrow in this space, Freedman believes that lower yields may not be good news for investors, but they could help generate a much needed increase in supply. “The good actors in this space, the companies that are making the positive transitions that benefit society and the environment, should be rewarded with a lower cost of capital,” Freedman says.


Engagement is a big part of sustainable investing in equities. Now that the strategy is moving to other areas, including debt, it has been difficult to have any influence over management in the same say that an investor with a sizeable shareholding would have. Yet all is not lost.

Smaller private companies that rely on debt to fund their ambitions are more likely to listen because they need the money.

“Green bonds open the door for engagement in the fixed income market,” Gordillo says. “If 10 years ago I said I was going to do engagement with a sovereign bond issuer I would have been laughed at.”

The need to meet climate change targets that they set themselves and by the Paris Accord mean that they prove their he adds, pointing out that governments want to discuss how to understand the areas where they could make an impact.

“Green bonds have allowed us to engage with fixed income issuers who were not part of our engagement radar,” Gordillo says.

He uses the example of Italian energy company Enel. It has agreed to pay its lenders more if the company missed certain renewable energy target. This was the result of senior management working with investors.


For Felipe it is important to see that the market continues to develop and improve that could lead to higher quality bonds being issued and better reporting, which he says is essential.

Rudgard adds that she does not believe the growing popularity declining. “If it is not green bonds it will probably move on to some of the other green financing options. “You will see a branching out in terms of people looking at the proceeds of companies and not just thinking about it whether it is a green bond or not but thinking about it from an ESG perspective.”

So sustainable debt has clouds of controversy hanging over it and concerns that investors are not being adequality rewarded for the risk they are taking. Yet steps are being taken by regulators and government bodies to bring clarity in the hope of increasing supply. Afterall, most projects that will give us cleaner energy sources, purer water and give access to healthcare and education are funded by debt. The market is in its infancy, but it appears that, in some form or another, it will be helping to fight climate change and improve communities.

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