Over the past few years, the green bond market has grown at an unprecedented rate, almost doubling from $50bn in 2015 to $80bn in 2016, and forecast to reach $150 billion by the end of the year. This week we caught up with Damien Lardoux, Portfolio Manager EQ Investors, to gain insight into this expanding market.

What is a green bond?

A green bond offers a financial return through the payment of its coupon like any other bond, but with one key difference: the money raised is exclusively assigned to finance projects and business activities labelled as green. Examples include, but are not limited to:

» Renewable energy

» Energy efficiency

» Clean transportation

» Low-carbon projects

» Pollution prevention

» Fishery & forestry

» Sustainable water management

» Environmentally friendly technology.

There is still a primary focus on achieving the maximum financial return but this consideration is balanced by environmental objectives.

Green bonds generally have a medium-term maturity of 5-10 years, are given credit ratings like other bonds and are issued in multiple currencies and from many issuer jurisdictions.

How large is the market?

At the end of June, the total market value of green bonds currently stood at $118bn. Although this represents a fraction of the overall £100 trillion bond market, demand is growing and the market is expected to double in size again this year, according to Moody’s. The climate-aligned bond universe is valued at $694bn, six times the size of the green bond-only universe.

When did they first emerge?

The labelling of green bonds is a relatively recent activity; the first green bond was issued by the World Bank in 2008, in collaboration with SEB, the leading Nordic Bank and Scandinavian Pension Funds. This followed on from the release, the previous year, of a Climate Awareness Bond by the European Investment Bank, which was the first to introduce the concept of tying revenues to climate investment.

Initially the growth of green bonds was driven by supranationals. Corporate involvement gradually became more pronounced until, in 2016, the number of green bonds issued by the corporate market outstripped those issued by international organisations like the World Bank.

Why the growing interest?

The 2015 Paris climate agreement saw nearly 200 nations agree to limit the global temperature increase to 2 degrees Celsius (the 2 degrees path). Recognising the opportunity, forward-thinking investors are identifying projects related to the shift to a lower carbon economy. Growth sectors such as renewable energy and electric vehicles needs financing. By 2020, the UK needs to generate 15% of its energy from wind, wave, solar and other renewable sources.

We’re also seeing an increase in environmental awareness, particularly amongst millennials and Generation Y. Both these generations have higher expectations of impact being ‘baked-in’ to their investments, rather than an optional extra.

Subsequently, we’ve seen demand for environmental, social, and governance (ESG) factors to be included in the investment process by fixed-income investors, which is something that can be fulfilled by the green bond market.

The International Energy Agency estimates that $93trn of energy investments are needed between now and 2035 to follow the 2 degrees path. Governments and supranationals will be unable to provide all the capital and capital markets will therefore have to fill in the shortfall with investments. Green bonds are now recognised as one of the key tools in raising the capital needed to achieve these ambitious climate change targets.

China’s clean energy campaign

China overtook the U.S. to be the largest issuer of green bonds last year, 39% of global bond issuance growth was accounted for by the country, mainly driven by commercial banks. The green bond market in China currently stands at $36.2 billion, but the country needs at least $300bn of green investment per annum over the next five years to help counteract environmental damage caused by the country’s rapid industrial growth.

But are they really green?

Whilst demand looks set to rise even faster in the months and years ahead, it’s not all been plain sailing.

One problem has been a proliferation of definitions, each claiming to accurately describe the characteristics of a green bond. For example, the commonly accepted definition of a green bond in China requires only 50% of the revenue from a green bond to be used for green projects, compared to a general international rule which expects 95% of revenue to contribute.

Another issue is that Chinese green bond guidelines allow funding for ‘clean coal’ power stations, which do not qualify under other market standards.

Widely-accepted industry standards are needed to address the growing risk of greenwashing damaging trust and actual efforts to finance environmental projects. In response, multiple efforts have been made to develop commonly accepted standards for green bonds to ensure a level-playing field in which the green credentials are clear-cut. These include:

» The Green Bond Principles (GBP) 

» The Climate Bonds Initiative (CBI)

» Moody’s Green Bond Assessment (GBA)

In the absence of a global standard, the majority of issuers commission external reviews of their green bond investment frameworks for the benefit of investors.

Several companies, such as Deloitte, Vigeo and CICERO have responded to this need. CICERO is the leading provider of second opinions and through its rating system, assigns each bond a ‘shade’ of green – the darker the green, the greener the bond.

Future outlook

As with any new product, a few teething problems are to be expected. However, the outlook for green bonds looks positive. The World Bank has projected an annual investment by cities of $100.0 billion through 2050 to prevent the harmful impact of climate change. The United Nations has estimated an annual investment of $1.0 trillion by global economies toward sustainable infrastructure development to dispel the effects of climate change.

The majority of mainstream index providers have added green indices to their library, a sign of the market’s growing maturity. These include the Bloomberg Barclays MSCI Green Bond Index and the Standard & Poor’s Green Bond Index, both set clear guidelines on what constitutes a green bond.

There has also been moves towards impact reporting by green bond insurers on the bonds’ use of proceeds. Quantifying the climate or environmental impact is critical to helping investors measure the positive outcome of their investments.

How to get involved

Over the last twelve months, we have seen the launch of a number of green bond funds in Europe. Within the EQ Positive Impact Portfolios, our preference is the Allianz Green Bond fund, managed by an experienced team that ensures selected investments have a high impact on the environment while not being detrimental to society.

This article was created by DISCUS based on the recent article written by Damien Lardoux for EQ Investors. You can find out more about EQ Investors and their discretionary investment services here