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Green bonds need to overcome growing pains to have real impact, experts say

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Green bonds need to overcome growing pains to have real impact, experts say

The global market for green bonds is maturing but needs to overcome issues around pricing, greenwashing and standardization in order to make a significant contribution to the clean energy transition. Particularly the harmonization of reporting regimes is key to advancing the sector, while other financing instruments are needed as well to absorb capital freed up by fossil-fuel divestment, according to asset managers and industry experts who gathered at a clean finance event in London on Oct. 9.

Investors in recent years have increasingly flocked to the burgeoning market for green bonds, which are typically earmarked for climate and environmental projects such as renewable power generation, energy efficiency or pollution prevention. Although some growth forecasts for the sector, including from rating agency Moody's, have recently been cut, the green bond market was roughly $160 billion last year and could break the $200 billion-mark in 2018, according to Vikram Widge, the global head of climate finance and policy at the International Finance Corp.

But investors looking to derisk their portfolio by divesting from carbon-intensive sectors in favor of climate bonds, for example, are facing numerous headwinds, said Brian Rice, a portfolio manager in the corporate governance department of the California State Teachers' Retirement System.

"We would like to grow our [green] investments — they are growing. [But] I would say the pace is slow, and there are a few challenges," he said. The agency has approximately $300 billion invested in green bonds and the teachers' retirement system's low-carbon assets and investments altogether add up to about $11 billion, or 5% of the agency's portfolio, according to Rice.

SNL ImageGreen bonds can be used to finance renewable energy projects such as wind farms.
Source: Associated Press

Chief among those challenges are the various existing standards for green bond issuance, which risk fragmenting the market and thereby hindering investment, the IFC's Widge said. The IFC is part of the World Bank Group and supports private-sector development in developing countries. In March, it launched what it said was the world's largest targeted green bond fund focused on emerging markets together with Amundi Asset Management SAS, which expects to deploy $2 billion over the fund's seven-year lifetime.

The International Capital Market Association last updated its Green Bond Principles, a list of voluntary guidelines for issuing green bonds, in June. That instrument is one of the ways in which standardization and alignment could come to the market, Widge said. "Harmonization is going to be key so as not to confuse investors," he said.

The same problem can arise around environmental, social and governance reporting: According to Maximilian Horster, managing director at ESG data provider and advisory firm ISS-Ethix Climate Solutions, there are now 19 different reporting regimes investors are exposed to, something the Financial Stability Board's Task Force on Climate-Related Financial Disclosure is trying to harmonize.

'Not the trillions we need'

Other issues include integrity, particularly around the so-called green-washing of bonds, and building capacity by bringing in the next set of target issuers such as municipalities and corporates, Widge said. During a recent climate summit in California, the World Bank and European Investment Bank, along with several others, launched a partnership partly to help underwrite and derisk green bond issuance so that a broader range of issuers could come on board.

Although the green bond market is growing, "this is not the trillions we need," Widge said. "How are we going to get this to scale at the speed we need to? That I think is the biggest challenge facing the green bond market right now."

Although Widge thinks green bonds are one of the safest bets for raising clean investment partly because bonds are a $200 trillion global market and an asset well understood by investors, others make the case that the broad range of standards and different bond offerings mean that, in a lot of cases, investors are simply not educated enough to properly assess the opportunities and pitfalls of green bonds.

"There is a real lack of evidence about what is the risk-return story is in these emerging asset classes," said Charles Donovan, who directs the Centre for Climate Finance and Investment at Imperial College Business School in London. "In a lot of situations, investors are flying blind with regards to whether that is both positive from an environmental or social point of view and meets their fiduciary responsibility to those that are invested in their funds."

And despite many investors' recognition of the growing demand for moving out of carbon- and asset-intensive sectors like oil and gas, there is no sufficient market yet to welcome that freed-up capital, Donovan added. Although green bonds are one way to funnel that money into financing the energy transition, additional instruments are needed.

"As of today, we simply do not have the products or companies that could absorb that volume of capital and allow for that transition to occur. And that’s where we're stuck" he said. "I think green bonds are a good example of a new instrument that tries to move towards this direction. But it's only the beginning.

"We’re basically at the birth hour of new instruments, and I think green bonds are a little bit ahead of the curve because they've been around for quite some time and have seen quite some growth, and they are also a breeding ground to try out new ideas."

More specialized products are already available. The IFC in 2016 issued one of the first bonds to specifically prevent deforestation in developing countries, for example, and Widge said the institution is keen on replicating them. Another climate-linked instrument, to be launched soon, is a "Breathe Better Bond" that will aim to offer municipalities a way to raise money for addressing issues such as local air pollution and industrial efficiency. This would hopefully engage philanthropy to provide "some sort of results-based incentive to bring down the cost of borrowing," Widge said.

But even with innovative funds and products, pricing will remain a challenge in the green bond market, he predicted. "Green bond investors want to make sure it's green, so it needs to be prevalidated, then they need impact reporting afterward on what the money was used for – nobody asks that of the 'plain vanilla bonds' and nobody is willing to pay the additional to the issuer," he said.