The Rise of Green Bonds and the Promise of Sustainable Finance
As the world grapples with the urgent need to address climate change, the sustainable finance sector has emerged as a powerful force for driving change. At the forefront of this movement are green bonds – a specialized type of bond that raises capital for projects with environmental benefits, such as renewable energy, energy efficiency, and ecosystem restoration.
The origins of green bonds can be traced back over a decade, when the World Bank and the European Investment Bank pioneered these innovative financial instruments. These early pioneers faced a daunting challenge – not just developing a bond prototype tied to environmental impact, but creating an entirely new class of securities that would be credible, replicable, and attractive to both institutional investors and environmental organizations.
To my surprise, they succeeded beyond anyone’s wildest expectations. According to the Climate Bonds Initiative (CBI), from 2008 to 2018, dozens of institutions and governments issued more than $521 billion in green bonds. And in the first half of 2019 alone, new certified green bond issues topped $100 billion globally, with forecasts for the full year reaching as high as $250 billion.
The growth of the green bond market has been nothing short of dramatic. As Kenneth Lay, senior managing director at RockCreek, who led the World Bank’s green bond development team, explains, “Earmarking bond issue proceeds for specific climate and environment-related projects was a major change that carried the potential to attract new impact-oriented investors and boost incentives within the Bank to focus on these key public goods. That potential is being realized, perhaps not as quickly as we all would like, but the progress has been dramatic in the decade since.”
Verifying Environmental Impact: The Challenge of Transparency
However, the success of green bonds has not been without its challenges. One of the most significant hurdles has been ensuring that the environmental impact of green bond projects is transparent, verifiable, measurable, and compliant with international standards.
From the outset, the World Bank developed a rigorous and transparent model for verifying its green bond issues. Since then, several robust and influential frameworks and protocols have emerged to guide investors and issuers, such as the Climate Bonds Standard and Certification Scheme launched by the CBI in 2010 and the Green Loan Principles developed by the International Capital Markets Association (ICMA) in 2014.
These voluntary frameworks have gained authority by assembling teams of top scientists and leaders to develop and promote rigorous standards, and by winning the endorsement of a critical mass of issuers and investors. As a result, ICMA and CBI have tailored most green bond issues to clear metrics and ensured that projects deliver relevant environmental benefits.
However, compliance with these standards must be independently verified. As Afsaneh Beschloss, founder and CEO of RockCreek, points out, “The internal incentives of asset owners are insufficient. Leading firms such as CICERO and Sustainalytics have conducted external reviews of more than 88 percent of the 5,000 bonds labeled as green by CBI. Such labeling means that at least 95 percent of proceeds go to environmental uses and that underresearched and controversial areas are excluded.”
The Perils of Greenwashing: Separating Fact from Fiction
Despite these efforts, the green bond market has not been immune to the perils of greenwashing – the practice of misrepresenting or exaggerating the environmental benefits of a project or investment. From clean coal projects in China to bonds sold by Spanish oil company Repsol, some issuers have blurred or obliterated the lines between sustainable and non-sustainable projects.
This backlash has sparked a more robust debate about the need for more precise definitions of the types of investments that contribute to sustainability and how much. As Mina Mashayekhi, senior advisor at RockCreek, notes, “Investors who adhere to the ICMA or CBI guidelines can be confident that they are supporting low-emission infrastructure and deep emission reduction – perhaps to a fault. For example, to avoid controversy, certification to the highest CBI standards skirts climate-relevant and investable areas such as nuclear energy and issues such as air travel, which accounts for 2 percent of the global carbon intensity of emissions and is growing.”
The challenge of distinguishing genuine green investments from greenwashing is not an easy one. It requires a nuanced, sector-by-sector analysis that takes time. As Beschloss points out, “The agencies have only recently explored frameworks for industries such as cement and steel, which together contribute 15 to 17 percent of global carbon dioxide emissions but are essential to building the infrastructure to shift from brown to green and to adapt to climate change, such as through electric-vehicle charging stations and floodwalls in low-lying areas.”
The Expanding Frontiers of Sustainable Finance
The growth and diversification of the sustainable finance sector have brought both opportunities and challenges. The Global Sustainable Investment Alliance estimated that $307 trillion in institutional assets across the world were invested in sustainable, environmental, social, and governance-focused or green products in six major markets at the beginning of 2018 – an increase of 34 percent since 2016.
Beyond green bonds, the sustainable finance landscape has expanded to include a range of innovative financial instruments, such as blue bonds, which fund coastal restoration, marine biodiversity, sustainable fisheries, and pollution control, and humanitarian bonds, which target pandemic disease and migration. The broader set of so-called “labeled impact bonds” is estimated to have a combined market value of up to $145 trillion as of 2018.
As the sustainable finance sector continues to evolve, it faces a critical challenge: ensuring that the risks and rates of return associated with these investments are fully transparent, comparable, and accessible in ways that can be consistently monetized. Beschloss explains, “The risk-return conundrum for those investing in green finance is pervasive and challenging. Should investors accept a lower return on green bonds from a given issuer than on that issuer’s ‘brown’ offerings? Should issuers expect lower financing costs – a so-called ‘greenium’? Should they accept lower internal rates of return on green private equity or infrastructure investments?”
These questions are not easily answered, but a compelling narrative is beginning to emerge from public and private sector data. Beschloss notes, “In case after case, green bonds fare better than their brown peers in pricing, liquidity, and performance. While a definitive conclusion remains elusive, investors appear to be able to invest in green bonds without hurting portfolio performance, and there is upside potential over time as climate-resilient assets prove to carry lower risks and the potential for better returns.”
Navigating the Sustainable Finance Landscape
As the sustainable finance sector continues to grow and evolve, institutional investors must become savvier in their approach. Long-term sustainable investors and asset owners must insist on rigorous analysis and a high threshold for institutional engagement. They will need seasoned, experienced, and nimble advisors and managers to help them navigate this complex landscape.
This is where companies like Firewinder come in. We are dedicated to providing comprehensive solutions for institutional investors and asset owners looking to allocate capital to the sustainable finance sector. Our team of experts helps clients navigate the intricacies of green bonds, blue bonds, humanitarian bonds, and other innovative financial instruments, ensuring that their investments align with their sustainability goals and deliver measurable environmental and social impact.
As the world continues to grapple with the urgent challenge of climate change, the sustainable finance sector offers a glimmer of hope. By channeling billions, and potentially trillions, of dollars into green infrastructure, renewable energy, and other sustainability-focused projects, we can collectively build a greener, more resilient future. But to realize this vision, we must remain vigilant, maintain the highest standards of transparency and accountability, and continuously push the boundaries of what’s possible.
The Road Ahead: Embracing Complexity and Uncertainty
The sustainable finance sector is a complex and dynamic landscape, rife with both promise and peril. As we navigate this uncharted territory, we must be prepared to embrace complexity and uncertainty.
Some experts believe that the growing scale, complexity, and diversity of green bonds and other sustainable finance products may pose the most significant challenge going forward. Mashayekhi cautions, “The question is whether such creativity is fostering a market in which risks and rates of return are fully transparent, comparable, and accessible in ways that can be consistently monetized.”
This is where the role of multilateral development banks like the Asian Infrastructure Investment Bank (AIIB) becomes crucial. The AIIB has set an ambitious target of ensuring that 50 percent of its overall approved financing by 2025 will be directed toward climate finance. The bank is also working to align its operations with the goals of the Paris Agreement by July 1, 2023, with a cumulative climate finance goal of $50 billion by 2030.
By collaborating with partners and unlocking new capital, the AIIB is helping to catalyze the development of commercially viable clean hydrogen, a transformative technology with the potential to revolutionize the energy sector. As the AIIB’s recent report “Financing Clean Hydrogen in Asia and Beyond” suggests, “Given the transformative potential of clean hydrogen but also the complexity of its value chain, it is necessary to identify where and how IFIs can engage in the hydrogen industry to be most impactful.”
As we move forward, it’s essential to recognize that the path ahead is not without its challenges. There will be ongoing debates, competing priorities, and complex trade-offs to navigate. But by embracing this complexity, remaining open to diverse perspectives, and continuously striving for greater transparency and accountability, I believe we can unlock the full potential of sustainable finance and build a greener, more resilient future for all.