Evaluating Green Bonds: More Information Will Boost Investor Confidence

Financial industry experts and policymakers agree that green investing, led by the private sector, is one of the keys to protecting the environment and accelerating the transition to a sustainable low-carbon economy. The growing popularity of financial innovations like green bonds underscores how rapidly progress is being made toward those goals.

But how can investors be sure a green bond is actually delivering on its promises? As the green bond market develops, credit rating firms and other industry players are offering evaluation tools to provide more and better information for investors.

Green bonds work just like other corporate or government debt securities, with a set interest rate and repayment of principal over an agreed upon time frame. The key difference is that the capital raised by the bond issue is pledged to environmentally friendly ends, such as cleaner renewable energy technologies like solar and wind power; sustainable land use and construction projects; or environmentally friendly transit systems that reduce carbon emissions, for example.

These financial instruments scarcely existed a decade ago, but since then the market for green bonds has grown dramatically worldwide. Moody’s Investor Services estimates green bond issuance volume will nearly double to $75 billion this year, according to a report in the International Business Times.

Growing investor demand also means a growing demand for reliable information about green investment vehicles and their results. The lack of a commonly accepted definition of “green investing” in this emerging market has made it difficult to quantify and validate the success of these projects.

After all, green investors aren’t interested only in their bottom-line returns — they also want to know their investment is having the desired environmental impact.

Clear-eyed, objective analysis of green financial tools is necessary to help investors make the best decisions and gain comfort that their green investments are being used as promised. Toward that end, a number of financial sector groups are developing tools to improve reporting and assessment of green bonds. A few examples:

· The International Capital Markets Association (ICMA) developed a set of “Green Bond Principles” to aid investors, issuers and underwriters. The principles are voluntary guidelines that “recommend transparency and disclosure and promote integrity in the development of the green bond market by clarifying the approach for issuance.”

· Moody’s Investors Services launched a green bond assessment (GBA) program in March 2016 offering a “consistent, standardized and transparent framework for evaluating an issuer’s approach for managing, administering, and allocating proceeds to and reporting on environmental projects financed by green bonds.” Since then, Moody’s has assessed several green bond issuances, including its first U.S. green municipal bond for a water project in New York’s Upper Mohawk Valley.

· Likewise, Standard & Poor’s (S&P) Global Ratings introduced its own Green Bonds Evaluation framework in September. The S&P product assesses green bond projects based on transparency, governance and effectiveness in mitigation and adaptation.

Those are just a few examples — others are quickly stepping up to offer competing products. This flourishing of information signals the evolution of the still relatively young green bond market; over time, more and better metrics will help investors compare qualitative performance of bonds. That’s an important first step toward a reliable rating system for green bonds, which will boost investor confidence in this growing sector.

Proponents of green finance rightly emphasize how these investments will go a long way toward building a more sustainable economy, while sparking renewed economic growth and creating new jobs. Enhanced disclosure and transparency will serve to nurture greater confidence in the potential of green finance to address some of the most pressing global challenges.

Matt Donohue, Moody’s senior vice president for global product management, explains that green bond market is positioned to continue growing, bolstered by improved information and reporting that helps investors to better assess the performance.

“We are seeing a growing number of investors, issuers and intermediaries who believe that green bonds are particularly well-suited as a source of capital to finance a transition to a low-carbon economy,” Donohue says. “Capital market financing needs — combined with rising demand for socially responsible investments, standardization of offerings and the issuance of benchmark-sized deals that are effectively priced — should increase green bond issuances for years to come.”

The road to a sustainable green economy isn’t going to be easy. But the rise of green finance, including the introduction of innovative tools to assess the performance of green securities, is a welcome development that will help to smooth the path forward.