Green Bonds: Truth vs Myths - Setting straight the recordResponsible investment 05 December 2018
The green bond market has grown rapidly in recent years. This is a testimony to the extent to which participants in the debt markets – issuers and investors - are increasingly playing a role in the global efforts to mitigate climate change.
AXA Investment Managers is an active participant in the green bond market. We consider it to be an efficient and effective way to transfer investment capital at scale to projects which can positively impact the environment and help society deliver on the United Nations Sustainable Development Goals. We have supported the market’s growth with 3 billion euros of green bond investments1 and this has established us as a leading investor.
Green bonds have been in existence for a decade now and even though it remains a small part of the broader market, we are gradually seeing a mainstreaming of the asset class. At the same time, we also continue to encounter a number of stereotypes, some of which are misconceptions, about the market.
Here, we consider some of the most common stereotypes and assess whether they are true or false:
1. Green bonds are project bonds
FALSE – Green bonds are not project bonds. In almost all cases, green bonds are senior unsecured debt where the credit risk is at the issuer-level. This is the most common form of bond issuances. We consider this to be one of the key reasons for the widespread take up of green bonds by benchmark-sized bond issuers and mainstream institutional investors. As the green bond market has evolved recently, there has been subordinated bonds and other security types such as asset-backed bonds.
2. Green bonds perform differently
FALSE – Green bonds are senior unsecured bonds. Assuming all of the bond’s features (issuer, maturity, currency etc.) are the same except for whether it is green or “grey” (non-green bonds), research points to no significant difference in the primary or secondary markets2.
3. Investors don’t know what the green bonds are financing
FALSE - The key difference between a green and a grey bond is that the former’s proceeds are used specifically for financing projects with an environmentally positive purpose. Grey bond’s proceeds have a wide range of uses but in majority of cases are for general corporate use. As an absolute minimum, we expect issuers of green bonds to be transparent about how proceeds will be used. The nature of transparency does vary. Some disclose details on every specific project financed per green bond. Others may not provide that level of granularity as it may be impractical to do so. It may be financing thousands of small projects which has met the issuer’s own environmental criteria.
4. Green bonds do not adhere to any standards
TRUE – Green bonds are not required to adhere to any standards. There are respected standards out there such as Climate Bond Initiative’s certification but these are currently only adopted by a small number of issuers. The key industry-accepted guideline for defining a green bond’s characteristics are the Green Bond Principles. It has four pillars around the use of proceeds, process for project evaluation and selection, management of proceeds, and reporting. It is, however, voluntary in nature so there are no hard rules requiring a green bond issuer to adhere and comply with the Principles. That said, it is rare to encounter green bonds which ignore the Principles. We are now seeing different local approaches adopted as the market has grown around the world. This includes a Chinese variant for local issuers. As a result, we do not accept the green bond label at face value and our team of experts actively conduct due diligence on each of the green bonds AXA Investment Managers invests in. We have established an internal assessment framework against which each bond is assessed. This is a key component of our investment process to ensure that green bonds which fall short of our expectations (and those some have labelled disparagingly as “green-wash” bonds) do not inadvertently end up in our portfolios. Our green bond strategy has obtained third-party certification via the Energy and Environment Transition for Climate (TEEC) label. There are increasing calls for industry-accepted standards for green bonds such as from the The EU High-Level Expert Group on sustainable finance.
5. Green bond issuers can operate in a way which damages the environment
TRUE - There is nothing stopping a company with environmentally damaging practices which has been involved in serious controversies from issuing a green bond. There are already specific examples to date. Some investors choose to focus solely on the environmental benefits of the bond – but our assessment framework demands we carefully analyse the issuer’s broader environmental, social and governance practices (ESG) and performance. Where we conclude that the practices do not meet our expectations, the bond is ineligible for investment.
6. Green bonds do not bring any additionality
JURY IS OUT - Additionality is an important concept. It can be defined as an outcome which is environmentally or socially better than the baseline scenario and which was achieved due to the financing of the specific project. It would be difficult to claim currently that most – if not all – of the projects being financed by green bonds would not have raised the money from another source. However, we consider that the green bond market’s additionality can also be measured in other ways. We consider the long-term shifts in company’s business practices including the management’s understanding of environmental risks and opportunities. Another long-term impact of participating in the green bond market is in continuously developing a transparent and effective system for transferring investment capital efficiently. The green bonds market needs to be successful as there is an estimated extra $3.5 trillion per year in investments needed to ensure sufficient climate change mitigation.
1 - 3.1 billion euros as of 30 September 2018. AXA Investment Managers. There is a small portion which are bonds labelled by issuer as social or sustainability bonds.
2 - HSBC Credit Research (2016) and Climate Bonds Initiative (2017)
3 - International Energy Agency / OECD / IRENA “Perspectives for the Energy Transition” (2017)
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