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Green Bonds Need the Right Filter

Green bonds are attracting a growing army of well-intentioned sponsors, certifiers and investors. They need to be careful not to let their own agendas undermine the market’s success.


First issued in 2007, green bonds are debt instruments intended to fund projects with environmental benefits. The market has expanded sevenfold in five years, catching up with a growing investor interest in sustainability. By some estimates, there are now half a trillion dollars worth outstanding.


Some bonds are intuitively green, such as those that fund the construction of renewable-energy projects, others less so. Spanish oil-and-gas company Repsol in 2017 issued a green bond to fund energy-efficiency investments in chemical and refinery facilities. Last year, Teekay Shuttle Tankers—a subsidiary of crude-oil tanker company Teekay —received a green designation for a bond funding new tankers with electric motors. Both Repsol and Teekay received green certification from third parties.


While the bulk of green bonds finance projects in the more safely green territory, these examples highlight their big weakness: a lack of standardization.


The industry generally points to a broad and voluntary set of guidelines called the Green Bond Principles. External certifiers now include major credit-ratings firms such as S&P and Moody’s as well as specialized firms including Sustainalytics, Cicero and Vigeo Eiris, but each has its own methodology. Besides, only 17% of the market was externally certified as of 2019, according to the Climate Bonds Initiative. The same organization found that just 38% of green bonds provided postissuance updates on how bond proceeds were used.


The slow pace of standardization might reflect the incentives of industry players. The business of structuring and certifying green bonds only makes money if it has a large enough pool of qualifying investments. It if is too restrictive, there would be no market. And unlike credit ratings, which are based on age-old metrics such as debt to profits or assets, green credentials can be hard to quantify.

Largest issuers of green bonds in 2020, by issuance sizeSource: Dealogic*European Bank for Reconstruction and Development
Toyota Motor CreditNXPRepublic of ChileRoyal Bank of ScotlandConsolidated Edison Co of NewYorkCitigroupEBRD*Fannie MaeAvangrid$0 billion$0.5$1$1.5$2$2.5$3


As such, governments might be better suited to setting standards than the private sector. Earlier this month, the European Union began a process to establish a green-bond standard. This would be a good start, though governments, too, are prone to bias. China, for example, only excluded “clean coal” from the list of projects eligible for green bonds last month, after facing criticism that the fuel doesn’t meet international standards. An EU standard could likewise favor technologies and industries that benefit European countries.


Investors aren’t naive about so-called greenwashing, by which companies market projects with questionable environmental benefit as green. Teekay’s green-bond issue raised only $125 million out of a targeted $150 million to $200 million.


The problem is rather that as the market grows, so will the temptation to loosen standards. Certifiers, facing more competition, will find it harder to reject business from large potential issuers. Green-designated funds will be tempted to broaden the definition of green when pressured to put more money to work.


Standards are especially important now that green bonds seem to confer benefits beyond favorable publicity, including cheaper borrowing costs. An ESG-themed bond—one focused on environmental, social and governance concerns—has the potential to price 0.05 percentage point tighter than a non-ESG-themed bond on new issues, and the differential can become even more pronounced in the secondary markets, according to Andrew Karp, head of global investment-grade capital markets at Bank of America.


For this reason, some renewable-energy companies that initially didn’t think it was worth the extra cost and effort of labeling their bonds green have jumped on the boat. In Brookfield Renewable Partners ’ most recent green-bond issue, roughly one-third of participants were green-only designated accounts, according to Wyatt Hartley, chief financial officer. While it is possible those accounts would have bought the bond without the green label, Mr. Hartley says the company is better off having done the certification legwork before the market grows even larger. He thinks it could lower the company’s cost of capital in the future.


The remarkable growth of green bonds is a testament to genuine recognition that climate risk matters. But as the market snowballs, green boosters on Wall Street will need to think beyond their own immediate interests. Pull too far, and they risk unraveling the market fabric.


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