If the world is to go green, it is going to take a lot of greenbacks. Companies that are switching steel mills from coal to renewably generated hydrogen, or developing alternatives to disposable plastic packaging, need cash. And governments that are planting more trees, or insulating old homes, will need loans.
Thankfully, investors — keen to be seen as responsible and eager to tap a growing market — are willing to provide it.
To date, they have cumulatively loaned $2.3tn in the form of green bonds, according to the Climate Bonds Initiative (CBI) — a non-profit organisation that promotes investments to combat climate change.
But there is just one snag: defining what a green bond is. Charges of ‘greenwashing’ — making unsubstantiated environmental claims for financial gain — have multiplied since corporates and government entities got involved in the bond market more than a decade ago.
In 2007, the first green bond was issued by the European Investment Bank, and other multilateral development banks followed suit. Then, in 2017, Spanish group Repsol became the first oil company to issue a green bond, using the proceeds to upgrade its refineries to emit less greenhouse gas. Last year, Hong Kong Airport Authority raised $1bn via a green bond tranche to help fund the development of a third runway.
Assurances over the green credentials of these bond-funded projects are currently provided only by voluntary standards.
The International Capital Market Association (ICMA) standards, drawn up by the membership body of investors, are the most popular. The CBI has also developed its own Climate Bond Standard with stricter requirements. This CBI standard includes a taxonomy with screening criteria to define green economic activities, and requires green bonds to be certified by approved external reviewers. In 2020, about a quarter of green bonds worldwide were issued under the CBI standard.
In addition, the People’s Bank of China, the China Securities Regulatory Commission, China’s National Development and Reform Commission, and the country’s Ministry of Finance each have their own eligibility criteria for green bonds.
But these are full of loopholes, according to the CBI. It found that 38 per cent of the total Chinese green bond issuance in 2017 — worth $14.2bn, or Rmb94.3bn — did not meet its green bond definition. And that percentage increased to 44 per cent in 2019.
Enter the European Union. Identifying a regulatory gap, Brussels has moved to plug it. The EU has largely built on the CBI standard, but used its own taxonomy, which was developed to determine what constitutes a sustainable investment in a number of sectors.
The European Green Bonds Standard (EUGBS), was provisionally agreed in February. It will enter into force one year after final negotiations between the EU institutions finish.
All companies using the standard will be required to disclose not only information about how their green bonds’ proceeds will be used, but also to show how those investments feed into the transition plans of the company as a whole.
This is important, argues Thierry Philipponat, chief economist of Finance Watch, a campaign group. “Money is fungible,” he points out, and gives the example of “a company that is borrowing to make 20 per cent of its assets sustainable but the other 80 per cent remains unsustainable.”
He says there is currently no guarantee that businesses are not just taking a slice of investment that they would have made anyway, and packaging it up as a green bond to attract investors. There is little evidence that green investment is changing behaviour.
So, while he welcomes the EU standard, he says it should be compulsory. “What’s the logic of an optional regulation?” he asks.
Another weakness is that, because of fierce lobbying by industrial groups, 15 per cent of the money in a green bond can be invested in economic activities that comply with the taxonomy requirements but cannot be determined to contribute to a green objective.
Such a “flexibility pocket” is necessary, says Florence Bindelle, secretary-general of EuropeanIssuers, a body that represents listed companies. “This is needed for those sectors not yet covered by the EU taxonomy and for certain very specific activities,” she argues.
The EU does provide for a system of external reviewers, though — independent entities responsible for assessing whether a bond is green. A supervisory body will identify and manage conflicts of interest.
Paul Tang, a Dutch Socialist MEP who worked on the rules, believes the system can act as a “gold standard”. “It ensures that the money raised must go to green activities and that bonds are vetted by professional and independent third party reviewers,” he says. “This is a world apart from current market standards.”
However, some experts think it is insufficient. Recent Danske Bank research found that the taxonomy alignment figures reported by companies in the Nordic region — arguably one of the most advanced in environmental regulation — were tiny.
Assessing 75 companies, the bank found that the average taxonomy alignment for capital expenditure was 14 per cent. Some 39 out of the 75 reported zero revenue alignment while 56 reported that less than 10 per cent of their revenue was aligned.
Another problem is that green bond yields are no longer higher than conventional bond yields, reducing the incentive for investors.
Jochen M Schmittmann and Yun Gao of the IMF have found that only strong regulation and a pressure on companies to reduce emissions through the introduction of a carbon price will create a “greenium”.
“First, to support the green bond market to work at scale, policymakers need to introduce a carbon pricing mechanism to generate transition risk which, in turn, provides an incentive for investors to buy green bonds,” they write.
In short, the only way to drive out greenwashing is to make it unprofitable.
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