Impact Investing Spotlight: Green Bonds

By Eric Davis, Investment Advisor Representative

In the vast world of socially responsible investing, the term “green bond” has been floated around quite frequently. But just what is a green bond? Well, it’s like any other bond, but the purpose of the proceeds are used for environmentally positive causes. Projects can be for renewable energy, clean transportation, biodiversity conservation, climate change adaptation, etc. In terms of the structure of a green bond, here’s the breakdown of the 4 different types with some examples.

The green bond market has exploded over the past couple years, from $11B of newly issued bonds in 2013, to $36.6B in 2014 and an expected $100B in 2015, although the current figure may become lower. The goal of the bonds is similar to what the telecom industry strived to do from the late 1990s through the early 2010s — create the infrastructure now for a sustainable industry in the future, leveraged with debt.

This all sounds like great news, right? Well, the article would stop here if that were the case. But just like anything in life, there are always two sides to a coin. This poll done by the CFA Institute summarizes the concerns of investors in regards to green bonds:

Luckily for you, the first issue may hopefully be answered by the end of this article. The 2nd and 3rd point are the two significant and real gripes with green bonds. As these two points are addressed, the number of issues may rise and address issue number 4. Although $36.6B is a lot of money, it is a drop in the bucket compared to the $100 trillion global debt market.

When it comes to green bonds, the validity of what makes a bond “green” can be hard to confirm. Green bonds are stated as such through self-certification, as in the company makes a claim that their bond is green and must provide evidence to investors to back up their claim. Although the issuer takes on increased reporting costs, they receive benefits like positive marketing through highlighting their green assets/business, attracting socially conscious investors, and doing so provides a chance for internal environmental teams to work with Investor relations at investor roadshows.

Providing this information comes at a cost to the company though. Some issuers of bonds may be eligible for “green” status, but may be deterred by the extra reporting. Those companies that are willing to take on the extra costs may be inclined to falsify or exaggerate the “green” aspect of their bond in order to maximize these added benefits.

Another tricky aspect of the reporting process is that there are no set standards or requirements for reporting. Investors can be left confused on the definition of certain terms and the presentation of data. When there is no continuity between reports, comparing two green bonds can become difficult, leaving investors to wonder which bond is more “green” than the other. Efforts have been made by the International Capital Market Association (“ICMA”) and other groups to standardize reporting. In ICMA’s “Green Bond Principles”, they cite 4 principles that all companies should follow when issuing and reporting green bonds:

  1. Use of Proceeds
  2. Process for Project Evaluation and Selection
  3. Management of Proceeds
  4. Reporting

These guidelines were developed in 2014 for a very young market, so although it’s a step in the right direction, there is still a long road ahead. The presentation of data and other fine details one would see in a company’s Annual Report do not exist at this moment. Large investment firms such as Blackrock and Pimco are asking for a standardized set of requirements.

Developing standards would allow for more clarity on companies that may be in a gray area of whether investors are supporting an environmentally positive project. An instance of when such standards would be useful is the case of the Thai oil company Bangchak Petroleum Public Company Limited. Bangchak operates the largest oil refinery in Thailand, and also owns about 1,100 petrol stations in Thailand and Malaysia. However, they were able to release their first green bond for $92 million. How is it that an oil company is able to raise a green bond?

When we dig a little deeper into this story, we find that outside of their oil refineries, Bankchak has been ramping up its capacity to provide renewable energy. The company’s CEO has been adamant that all the money raised will be used for such projects. While the company may use the funds for renewable energy projects, the amount allocated can’t be verified. The use of green bonds by non-green companies may not be a bad thing; they can raise funds towards more environmentally rewarding endeavors in order to put themselves in a better position in the long-term. However, investors may not be comfortable placing their money in a green bond owned by a company that’s main operation is damaging to the environment.

There are extra steps that companies take to ensure investors the money is being used for its intended purpose. Numerous third-party firms provide second opinions on a green bond, including: CICERO — Center for International Climate and Environmental Research Oslo, Vigeo Rating, DNVGL, Oekom Research, KPMG, Sustainalytics. These firms ensure that the use of proceeds and the assets being funded are going towards environmentally conscious causes. As an investor, be sure to look for companies with a second opinion; this will be an aid in the decision process of whether a bond is green or not. Much like other rating systems, they are not perfect and investors should look for any compensation received by the third-party from the issuer.

As we can see, the concept of green bonds seems great; companies raise money for environmentally conscious projects and use the term green bond as a marketing tool. However, the execution of green bonds is flawed. Investors are unable to know whether the capital is going towards the desired cause, whether it’s due to a lack of oversight or universal standards. Companies that do follow the proper protocol to issue green bonds have to incur extra costs, which could deter them from labeling their bonds as green. The green bond market is small, but as more and more investors raise their voice and demand higher standards, the market may become more robust and grow.

This article appeared in issue 1.3 of Revaluation, a quarterly publication for Conscious Investors. Join our community here

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