Stephen Minas, PhD researcher, King’s College London
The emerging market for green bonds
The regulation of global financial markets is characterised by significant complexity. At the global level, one is confronted by a tangle of oversight institutions, including ‘an international body that audits the bodies that audit the auditors’. To the shake-up of rules brought on by the 2007-08 financial crisis can now be added an additional layer of complexity: the creation of securities with an explicitly environmental purpose and the challenges that this nascent asset class presents for both market participants and regulators. In particular, as green bond issuers, underwriters and subscribers quickly organise their own standards the question confronting regulators is whether, and how, to step in.
The market for green bonds has grown quickly. From a market of just $3 billion in 2012, Bloomberg New Energy Finance has predicted that issuance of green bonds will increase from $14 billion in 2013 to $37 billion this year. The World Bank Group began issuing green bonds in 2008 and was soon joined by other supranational development banks. Much of the growth of the last two years has come from private sector issuers. Municipal authorities are also getting in on the act, with Johannesburg issuing a $136 million green bond in June 2014.
Market analysts expect further growth to come from Asia. Last year, the Export-Import Bank of Korea issued a $500 million green bond, which the bank has stated it will use to finance ‘low carbon and climate resilient growth’ projects. The Chinese government has committed to developing a corporate green bond market.
There is no universally accepted definition of what makes a green bond. The World Bank selection criteria for eligible projects includes renewable energy, energy efficiency, sustainable forestry, etc. A 2012 OECD working paper which canvassed various definitions concluded that ‘[w]hile the development of clear standards would certainly be a useful step forward, when looking at how the term green bonds is currently used it is difficult to see a general consensus on a particular concept’.
The asset class is well-described by McCrone as ‘an umbrella term that encompasses several different types of security’, including bank-issued bonds to finance loans to climate projects, utility-issued bonds to fund climate-related capex, project bonds that finance a particular clean energy project, etc.
An example: The GDF Suez green bond
The recent GDF Suez bond is indicative of the kinds of projects financed by a green bond issue, the substance and process of ‘green’ criteria applied, market demand and reaction from environmental activists.
In May 2014, GDF Suez issued a $3.4 billion green bond – the largest issue to date. The French utility reported that 64% of the issue (which was three-times oversubscribed) was purchased by ‘environmental and socially responsible’-focused investors. The capital raised was to be used to finance clean energy projects including wind and hydro, energy efficiency projects and biomass-powered heating networks. GDF Suez developed a set of criteria for projects together with Vigeo, an external verifier specialising in environmental, social and governance issues. The criteria cover five areas: ‘environmental protection, contribution to local development and the well-being of local communities, fair and ethical relationships with suppliers and sub-contractors, human resources management, and good corporate governance’.
It is perhaps unsurprising that this brief press release attracted the suspicion of environmental activists. For example, the NGO International Rivers claimed that the GDF Suez bond could finance a ‘controversial’ large dam in the Amazon and on this basis attacked the bond as a potentially ‘disastrous investment for both people and planet’.
Regulation and market standards
In the absence of national or supranational regulation specific to green bonds, influential market participants have developed their own voluntary standards. In January 2014 a group of multinational banks including HSBC, JP Morgan Chase and others released the ‘Green Bond Principles’, which they describe as a set of voluntary guidelines for the issuing of green bonds. In April a secretariat for the Principles was established within the International Capital Market Association and in August an executive committee was appointed.
As of 6 November, membership of the Green Bond Principles had grown to include seventy firms and financial institutions, including issuers, underwriters and investors. The World Bank and other supranational banks are members alongside commercial and investment banks.
The Principles do not attempt to exhaustively define ‘green bonds’, recognising a ‘diversity of opinion’ on the topic. The Principles list the four current types of green bond (use of proceeds bond; use of proceeds revenue bond; project bond; and securitized bond) but note that ‘additional types may emerge as the market develops’.
The Principles cover use of proceeds; process for project evaluation and selection; management of proceeds; and reporting. A disclaimer emphasises the voluntary nature of the Principles and, inter alia, absolves underwriters of responsibility if ‘issuers do not comply with their commitments to Green Bonds and the use of the resulting net proceeds’. The Principles will be updated in 2015 following industry consultations.
Voluntary industry standards such as the Principles are a familiar feature of transnational markets. According to Brunsson and Jacobsson, a ‘typical standard consists of a statement about the generally desired qualities of a product, an activity, or a document’. By making this statement of desired qualities available to a market, ‘[t]he standardizer seeks to regulate the design of these objects or processes’. This description matches both the form – seven pages including broadly worded standards, disclaimer and appendix – and the purpose of the Principles.
At this early stage of the market’s development, the Green Bond Principles are just one of a number of private standards being applied or in development. The Climate Bonds Initiative, a non-profit backed by large financial institutions, has developed its own ‘prototype’ standard for ‘climate bonds’. Another example is the Principles for Responsible Investment (PRI), which incorporate environmental, social and corporate governance issues into investment management. PRI signatories have a total of $45 trillion under management. Different external verifiers will also have their own criteria and may (as the case of GDF Suez indicates) develop criteria specific to a particular client or issue.
The development of self-regulation has parallels in other markets of environmental significance and may not be a passing phase. In the forestry industry, for example, the Forestry Stewardship Council and the Program for the Endorsement of Forest Certification continue to offer competing standards and are both forms of ‘non-state market-driven governance’.
In the case of green bonds, the obvious question is how effective private standards will be in securing outcomes consistent with the environmental aspirations they embody. As the first wave of shorter-dated corporate green bonds start to mature, investors, activists and regulators will be watching.
New asset class, familiar trade-offs
In reporting on green bonds, The Economist recently observed: ‘Occasionally a market appears out of nowhere’. Green bonds have not exactly done that. In the two decades and counting since the United Nations climate change convention was agreed, multiple public and private sector actors have experimented in how to finance climate change mitigation. For the supranational banks which originally issued them, green bonds were in part a response to the reality that public financing for climate mitigation will continue to fall far short of what the International Energy Agency says is required. For the institutional investors subscribing to them in growing numbers, green bonds are in part a hoped-for ‘safe’, long-term investment, and in part an instrument for hedging ‘stranded asset’ scenarios.
There is already huge market demand, with many bonds oversubscribed and some selling out within minutes of being issued. Nevertheless, the quick growth of the market has left multiple questions for issuers, subscribers and regulators to contend with.
The chief investment officer of Zurich Insurance, which has committed to significant investments in green bonds and subscribes to the Green Bond Principles, recently warned that ‘if there is going to be a lot of “green washing”, this market will die. It’s in our best interests to safeguard the integrity of this market, otherwise it will be a one-time show’. As the OECD has noted, the trade-off is between a broad definition of green bonds which risks ‘green washing’ and a more rigorous definition which comes at the expense of scale.
Concerns about asset class definition and ‘green washing’ could grow if non-specialist investors increase as a proportion of subscribers. The Climate Bonds Initiative estimated 2013 demand for green bonds from subscribers with a ‘sustainability mandate’ at between 58% and 80%, meaning that mainstream investors already made up a significant portion of the market. Green bonds have an obvious attraction as ‘solar funding for the rest of us’, in the words of a recent Forbes article. Nevertheless, non-specialist investors could find themselves poorly placed to assess how ‘green’ a bond is, especially if confronted with competing voluntary standards.
A further issue is the reality that ‘some green bonds are greener than others’. As McCrone suggests, confidence in the green bond market is likely to be bolstered by the development of a system for rating the ‘shade’ of a green bond.
Whether green bonds catch the eye of financial regulators or continue to be self-regulated is an open question. It is likely to attract further scrutiny. While all the bonds being held out as ‘green’ still constitute a tiny fraction of the global bond market (0.04%, according to one estimate), they are projected to become an increasingly significant proportion of overall climate finance, meaning concern for the integrity of this market extends far beyond the immediate parties.
 Elizabeth Coston, et al, ‘Next Season’s Green Bond Harvest: Innovations in Green Credit Markets’, IFC & Kellogg School of Management, June 2014,p 8.
 G. Inderst, C. Kaminker and F. Stewart, ‘Defining and Measuring Green Investments: Implications for Institutional Investors’ Asset Allocations’, OECD Working Papers on Finance, Insurance and Private Pensions, No. 24 (2012) p 30.
 Nils Brunsson, Bengt Jacobsson, et al, A World of Standards (Oxford: 2000) p 126.
 Olga Malets, ‘The Effectiveness of Transnational Non-state Governance: The Role of Domestic Regulations and Compliance Assessment in Practice’, Max Planck Institute for the Study of Societies, Discussion Paper 13/12 (2013) pp 6-8.
 ‘Energy Technology Perspectives 2012: Pathways to a Clean Energy System – Executive Summary’, International Energy Agency (2012) p 1.
 John A Mathews and Sean Kidney, ‘Financing climate-friendly energy through bonds’ (2012) 29(2) Development South Africa 337, p 347.
 Christa Clapp, ‘Climate finance: Capitalising on green investment trends’, in Heleen de Coninck, Richard Lorch and Ambuj Sagar (eds), The Way Forward in International Climate Policy: Key Issues and New Ideas 2014, Climate and Development Knowledge Network and Climate Strategies (2014) p 44.
 Inderst, Kaminker and Stewart, p 30.
 Clapp, p 44.