Standard Life Investments

Focused Insight

How green are ‘green bonds’?

  • Green bond issuance is growing rapidly globally but there is no single definition of the term.
  • A label is not enough. Investors need to take a holistic view of a company’s behaviours.
  • Green bonds are more, not less, exposed to environmentally related credit risks.

The August announcement by Tianjin SDIC Jinneng Electric Power Co Ltd that it had issued green bonds worth RMB1 billion ($150 million) to finance a 2,000 megawatt coal‐fired power plant neatly encapsulates the conundrum of green bonds. The United Nations’ Clean Development Mechanism aims to fund carbon‐cutting projects and clean coal falls into the list of sectors eligible for green financing. But, as Greenpeace campaigner Huang Wei rightly points out, “The ‘clean’ in clean coal is a relative term. Technology such as ultra‐low emissions, albeit producing fewer air pollutants, is not a solution to lowering the carbon emissions that endanger our climate”.

What are green bonds? Do they help the environment? And what should an investor who invests in green bonds expect?

What are green bonds?

While there is no single definition of the term, green bonds are generally considered to be bonds that will be exclusively used to finance (or refinance) a new or existing project that tackles environmental issues. They were originally issued by multinational development banks. The European Investment Bank brought the first green bond to market in 2007 and issuance has increased rapidly in the last five years, in line with the wider growth seen in socially responsible investing (SRI). The global green bond market has grown from below $10 billion in 2012 to aggregate issuance over $100 billion in 2016 and $60 billion in the first‐half of 2017 (see Chart 1).

: Green bond issuance

'Greenwashing'

The principles behind green bonds are admirable, but the realities will not always match an investor’s expectations.  The green label is not always deserved. 'Greenwashing' is to SRI financing as 'whitewashing' is to politics. Embarking on a green project is not enough to make a company socially responsible. Investors need to take a holistic view of a company values and behaviours. There are four issues we highlight.

  1. ‘Green’ has more than one dimension, as made obvious in the coal project example above. Investors need to decide what matters to them.
  2. Green bonds can be issued at a project level. They tell us nothing about the overall operations of a company, nor its overall financial health.
  3. Most green bonds only consider the environmental impact of an investment and take no account of the social consequences. For example, a hydroelectric dam may well be eligible for green‐bond financing, but its social impact could be extremely negative.
  4. Bonds that are green at issue may not remain so.

Credit spreads, investment performance and credit risk

What should an investor who invests in green bonds expect? Issuers of green bonds were able to borrow at lower spreads than if they had issued conventional bonds, with interest rates 18 basis points lower, according to Green bond finance and certification, a report by T. Ehlers and F. Packer, published in the BIS Quarterly Review, September 2017. The study examined the pricing, performance and environmental risk of green bonds. They found that green bond indices produced similar returns to global bond indices (after hedging currency exposures and using like‐ for‐like credit rating compositions).

Perhaps the most counter‐intuitive finding was on credit risk. They found that green bonds are more, not less, exposed to environmentally related credit risks (see Chart 2). This reflects two facts. First, most green bonds are backed by claims on the overall company, not the green project itself. And second, the issuers of green bonds typically operate in high environmental‐ risk sectors. That is, almost by definition, the nature of the companies that issue these bonds.

Environmental credit risk composition of all rated bonds versus green bonds only

Green enough?

Green bonds can bring benefits to borrowers, investors and the environment. But investors need to take a holistic view of both the environmental, social and governance (ESG) impact and credit risk of a company before investing. In providing finance to green projects, they may inadvertently be increasing the environmentally related risks in their portfolio

For more on this topic, read our white paper: Doing ‘the right thing and making money’: ESG and the corporate bond investor.