Road to COP26: Green bonds are the new stars of climate finance but questions remain

Some $33trn must be invested in low-carbon energy by 2050 to reduce emissions, according to the International Renewable Energy Agency. That sort of money can be found only on capital markets and investors are mobilising.

Global green bond issuance, which was almost non-existent a decade ago, reached $97bn in 2016, $290.1bn in 2020, and is now on track for a record half trillion year; it reached $496.1bn in the first half of 2021, according to figures from the Climate Bonds Initiative. For 2023, the projection is $1trn.

These record sales are pushing sustainable investment forward as issuers of green bonds raise money, promising to spend it on green projects ranging from electric buses to wind farms.

Green bonds are becoming the stars of climate finance; issuers now range from banks and companies to sovereign states.

Colombia and the UK are due to offer their inaugural green bonds this September to help pay for the transition to net-zero carbon emissions and deepen the markets for environmentally sustainable investments. 

The European Union is also entering the market and over the next five years, Brussels could issue up to €250bn in green bonds.

Green catalyst

Demand from ESG-conscious investors is high and not even the devastating pandemic has affected the surge.

“Green bonds have become a lot more mainstream as investors seek to allocate more to impact investments,” Nazmeera Moola, head of SA Investments at Ninety One, told Investment Week.

 The development of a transition bond framework under the green bond label to make sure high-emitting companies are able to raise enough capital to transition towards net zero should fuel even more investor appetite.

“They are also set to become increasingly attractive to issuers – as the scope expands to resilience bonds and eventually transition bonds.”

Once seen as a niche instrument, green bonds have become a viable addition to any mainstream credit portfolio, according to Noelle Cazalis, manager of the Rathbone Ethical Bond fund.

“We see green bonds every day. It very much feels like it is a mainstream funding instrument that is really well understood by the markets”, she said, predicting the market will continue to grow.

For Randeep Somel, fund manager at M&G, the rise of green bonds “shows companies are serious about the risks” of climate change. “Green bonds do work, you can clearly see that,” he added.

The green bond that wasn’t

When Mexico City Airport Trust issued $6bn of green bonds in 2016 and 2017 to finance the construction of a new airport the investor community welcomed the green issuance.

But when Mexico’s government decided to mothball the project in 2018, the decision did not trigger any sort of default on the debt. Some ESG indices have since expelled the bond, but it is still on the market – and investors have to take Mexico’s word that the proceeds are being used for environmentally friendly purposes.

“Non-performance relative to initial commitments has become a growing concern,” Moola admitted.

 “However, as the market grows and matures, we will start seeing protections built into these bonds.”

My-Linh Ngo, head of ESG investment at BlueBay Asset Management, said the lack of any guarantee the green bonds will deliver positive outcomes poses a challenge.

“Aside from the reputational impact of not delivering real world outcomes, there are no direct financial penalties of not delivering,” Ngo said. 

“Green bonds are necessary but not sufficient in and of themselves, to support the environmental transition.”

Cazalis said doing due diligence is key to tackle greenwashing. She gave the example of a wind farm construction project the fund was looking at that apparently ticked all the green boxes.

“But the construction was destroying a lot of mitigation pathways and had a really bad impact on biodiversity locally,” she said.  The team ended up saying no to the project. 

For Joshua Kendall, head responsible investment research and stewardship at Insight Investments, it is important to have an investment process that incorporates stewardship.

“We do not just see a green label and think this is great. We know these companies, we know their strategies and intentions,” he said.

Scott Freedman, fixed income portfolio manager at Newton Investment Management, agrees: “Investors must analyse the labelled bond market holistically. Active investors have the opportunity to look beyond labels, and avoid the risk of greenwashing.”

For Ngo, the thing to remember is that not all green bonds are equal. 

“Investors need to look under the ‘hood’ and evaluate the quality and integrity of the issuer,” she said.

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