The green bond market will get a boost from new EU proposals to set standards for the fledgling debt instrument, but do not expect a sudden flurry of issuances just yet.
The proposed EU Green Bond Standard aims to provide investors with a framework for issuing green bonds — debt that finances environmentally friendly projects such as wind farms or solar power — and could make the market more mainstream, experts say.
Although they represent a tiny fraction of the overall debt market, green bonds have grown rapidly over the last six years. Issuance totaled $169 billion in 2018 and is expected to rise to $250 billion in 2019.
But the market has been dogged by a lack of supply since its inception, with a limited number of projects and increased costs among the reasons why issuance remains low. At the same time, investor appetite is strong and green bond issues are regularly oversubscribed.
Governments and regulators are increasingly looking to the financial sector to finance the transition to a low-carbon economy. The EU's sustainable finance action plan, announced in March 2018, is designed to lead the way and foster investment.
The standard is part of the action plan and is linked to the EU's 414-page taxonomy intended to define "green" investments. The two were announced at the same time, and the Green Bond Standard will lean on the taxonomy to decide which environmentally friendly projects qualify for green bond funding.
Aila Aho, a member of the European Commission's technical expert group for sustainable finance and a rapporteur on the green bond standards, said in an interview that aligning the standards with the taxonomy will help clarify investor and issuer questions about what makes a bond "green." The standards will remove market uncertainty and reduce the reputational risk associated with issuing a so-called green bond that is no such thing, she said.
Aho is also an executive adviser on sustainability for Nordea Bank Abp.
Smaller asset managers will specifically benefit because they may not have the capacity to conduct detailed analyses, and the standard would provide them with the tools to do that, Aho said.
Although the standards will be voluntary, verification by external reviewers for bond issuers will be mandatory. They will also hold issuers to account by requiring mandatory publication of a green bond framework, which will set out the environmental aims of the green bond, allocation and impact reporting.
But Aho said it make take some time for the standards to boost supply, given that approval would need to wait for the new EU leadership to bed in. She said she expects to see an increase in issuance from 2020.
The EU is proposing the verification process be under the auspices of the European Securities and Markets Authority, which might take up to three years to establish. But Aho said she did not think that would hinder growth.
"We do not want the green bond market to stop and wait," she said. "We want it to develop."
The introduction of the standards will help gather data on green bonds and climate financing, something the market has been lacking, and that in turn should help spur issuance and create a "positive spiral."
But some have questioned the effect the taxonomy and standards may have.
Although they are designed to encourage the flow of money into green finance, they are adding layers to the process of issuing a green bond that could raise transaction costs and act as a brake on issuance, said Christa Clapp, climate finance research director at Cicero, a Norwegian think tank, which also provides second opinions on green bond issues.
The market is small and fragile, she said in an interview.
"You can protect against greenwashing and still encourage new issuers to come to market without 400 pages of baseline and threshold analysis," she said, adding that some green bonds in the market today would struggle to comply with the taxonomy.
But other market watchers say the standards will give an impetus to strong underlining demand.
June Choi, a climate finance analyst at the Climate Policy Initiative, said in an interview that the standards would give people in the market a sense of direction and lead to increased issuance. The verification systems bestows credibility.
The standards are a "natural evolution" in the growth of the market, said Tom Kinmonth, fixed-income strategist at ABN Amro.
"The green market is still really young. This is the next step," he said.
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