However, the long-term outlook for the market remains strong as corporates join the "green bond wagon," and government policies spur the transition to a low-carbon economy.
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Green bonds — debt that finances environmentally friendly projects such as wind farms or solar power — have grown rapidly over the last six years, from virtually none in 2012 to an estimated €210 billion worth in 2018, based on figures by the non-profit Climate Bonds Initiative, which promotes green investment. But the market accounts for a tiny fraction of total bond issuance and has been dogged by poor supply.
Demand has outstripped supply for the last couple of years, which is a market failure, Marcus Svedberg, investment strategist at the Fourth Swedish National Pension Fund, said in an interview. Growth is "stagnating a little bit," he said.
"People think green bonds are a great invention, asset owners and asset managers want to increase their exposure to sustainable assets ... but then the supply is just not there," he said.
Green bonds cost more and take more time to issue, so issuers see them as more complicated than traditional vanilla bonds, he said.
Lose-lose product
His words echo those of a senior executive at Japan's Government Pension Investment Fund, the world's largest pension fund.
At a financial climate conference in Paris in November, Hiro Mizuno, the fund's chief investment officer, said green bonds need to be redesigned.
"[The] green bond is still a lose-lose product," he said. "We need to redesign it to make it a mainstream investment product."
He said the market is unlikely to take off because green bonds are more expensive than their traditional counterparts, making it costly for the borrower. The lack of supply makes it a less liquid investment for investors, he said.
According to rating agency Moody's, new issuance of green bonds worldwide was roughly flat year over year in the first nine months of 2019 at €110.1 billion. Third-quarter issuance was down 30% compared to the second quarter, and down 18% compared to the third quarter of 2017.
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"We have seen slightly less accommodative market conditions and that has impacted the bond market and the green bond market has obviously felt some of that effect as well," Rahul Ghosh, a green bonds analyst at rating agency Moody's, said in an interview.
The growth of social bonds, which include bond issues to social housing projects, and sustainability bonds, which finance green and social projects, could also explain the slowdown in issuance, he said.
"You are seeing issuers diversify their capital raising plans and thinking not just through a green lens, but also through a sustainability lens," Ghosh said. "There is very healthy growth in the social and sustainability bond space. If you were to add that back in to green bond issuance volumes, you are still seeing ... double-digit expansion for thematic bonds as a whole."
Government action needed
Sean Kidney, CEO of the Climate Bonds Initiative, said the lack of supply was a "hindrance" to the transition to a low-carbon economy, and it was up to authorities to help.
"It is not just a market problem," he told S&P Global Market Intelligence on the sidelines of a conference at the British Embassy in Paris. "The difficulty here is that the bulk of it has to be mediated by government so it's regulatory issues, it's planning issues. If we were building the level of railways needed to achieve our transport emissions there would be not issues of supply."
Investors can also play a part by pushing companies they invest in on the equity side to issue more green bonds, and educating CFOs in what to hold in company portfolios would also bolster the market, he said.
Market participants said the current slowdown in issuance would likely be short term.
"It is not strange it is consolidating a little bit especially combined with the uncertain macro situation we are facing and perhaps changing momentum in terms of who is issuing," Svedberg said.
Development banks, which have been behind some of the large green bond issues on the market, are playing a smaller role, and more issuance is coming from different sectors, cities, municipalities, corporates and non-corporates from both developed and emerging markets, he said. Once an issuer has passed the hurdle of extra reporting they are more willing to return to the green bond market, he said.
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The EU announced its sustainable finance action plan in March under which it will create a EU-wide taxonomy, or classification, for green assets and EU green bond standards, and Svedberg said this would lead to a renewed push for issuance in 2019 and 2020.
Ghosh said investors were taking "a wait-and-see approach" with regards to policy developments that could affect the market.
Diversification on the market would also lead to greater growth in the coming year, he said. The market is seeing diversification into new geographies and new asset classes like green covered bonds, and a ramp up in green mortgage-backed securities, he said.
Limits
Market participants said, however, there was a limit to how much green financial products could achieve.
"The green bond market will remain relatively niche in the context of the trillions needed for us to transition to a lower carbon and climate resilient global economy," Ghosh said. "We are talking about $3 trillion to $7 trillion per annum over the next 10 to 15 years, so that is a huge amount of capital required and the green bond alone is not going to make that gap."
Its legacy will be showing how enhanced disclosure could be positive for both issuers and investors, he said.
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