Green bonds have come a long way since they were first issued in 2007. As we mark their tenth birthday, what developments should we expect over the next few years?
Green bonds use environmentally sustainable investments as a means to cut carbon emissions. The issuer uses the bond proceeds to finance or refinance construction projects or initiatives that improve the environment. Applicable projects could include renewable energy schemes, clean transportation and flood management initiatives. The green label is coveted by issuers, such as banks, companies and sovereign states, as it allows them to market their bonds as sustainable investments.
In 2007, when the first green bonds were issued, the value of the market was $0.8 billion. Ten years later the market has grown to $120 billion. Furthermore, a number of significant milestones have also been achieved in 2017. These include the issue of the world’s largest green bond, a $4 billion bond by the Mexico City Airport Trust to finance the new Mexico City international airport, and the issue by Fiji of the first sovereign green bond by a developing nation. The first green bond issued by a British bank to fund domestic assets has also been launched. Further developments can be expected, particularly in the following four areas:
- The market can be expected to grow further: Green bonds are a means of meeting climate change and sustainability targets. Facing an imperative to address pollution concerns and a commitment to adopting sustainable development under the Belt and Road initiative, China has overtaken the United States as the largest green bond issuer. In addition, green bonds present an attractive alternative liquidity source where some renewable energy initiatives are simply too large to be funded by bank debt. The cost of capital has also fallen through a combination of reduced project delivery risks and improvements in the technical expertise required for such projects. These factors are all leading to growing interest in sector opportunities.
- There will be increasing measures to regulate how bond proceeds are invested: Growing concerns regarding “greenwashing” and misleading claims about how bond proceeds will be used and which initiatives should qualify for investment could all lead to greater regulation. For example, should green bonds be used to finance airport development given its environmental impact and should clean coal, nuclear and off-set technologies qualify? Investors have been left to decide for themselves whether a bond merits a green label, although various organisations are available to certify bonds. In order to guide issuers on the appropriate use of proceeds, the International Capital Market Association (ICMA) offers Green Bond Principles. However, these initiatives are voluntary with no real means of enforcement. Opinion is divided as to what should be done. If a standard label is introduced for green bonds it must be properly coordinated, otherwise a bond could attract a green label in one jurisdiction but not another.
- Bond proceeds will be used to fund a more diverse range of initiatives: In an effort to promote greater integrity and transparency, updated Green Bond Principles were issued by the ICMA in June 2017. The principles amend the green bond definition to take account of bonds which have a social benefit. Green bond proceeds may now be used to fund research and development, waste prevention and reduction initiatives, sustainable fishery, agriculture and forestry, wastewater management and treatment schemes, and green buildings meeting recognised standards or certifications.
- Issuers of green bonds will face greater and more costly reporting obligations: Reporting is a key aspect of green bonds, with the issuer updating investors on how the bond proceeds have been used and on the associated environmental results. Most, but not all, issuers report annually. The content and quality of reporting varies which makes comparisons difficult. Recognising that more must be done, the updated Green Bond Principles require more information to be reported to investors. This now includes details of the criteria by which the issuer decided that the underlying purpose was green and the process applied to identify and manage environmental and social risks. The cost of reporting is likely to increase going forward, particularly given the growing trend towards impact reporting.
There has been tremendous growth in the green bond sector over the last ten years and further developments are likely. Indeed, such developments will be required if the green bond market is ever to reach its full potential.
Barry Hembling, Partner, Fladgate LLP (firstname.lastname@example.org)