Necessary Developments in the Green Bond Market
The advancement of human technology, production, capital, and capability has grown significantly in recent history while driving the global economy to be what it is today. The countless benefits have raised contemporary issues, with the pending deterioration of the planet’s climate and overall environment at the forefront. Global growth has exponentially increased human footprint, as we see increases in carbon footprint and decreases in the health of the Earth and many of its species. Politics, businesses, and people have transitioned intentions to “be green”, collectively and individually; however, these sustainable actions are still outweighed by the environmental consequences of our increasing footprint. According to IBISWorld, a leading research platform in business intelligence, the oil and gas drilling sector - the most notorious plague to the Earth’s health - consumed $3.3 trillion USD in 2019. This is 3.8% of the $86 trillion USD global economy (IBISworld, 2020); and the list of industries that negatively affect the environment ensues beyond this sector. A relatively new financial tool, the green bond, is increasing in popularity that can benefit both economic and environmental well being.
Since its original issuance in 2007 by the European Investment Bank, the market of the green bond has seen new and enthusiastic issuers emerge such as supranationals, national sovereigns, corporations, and American and international municipalities. The rising popularity behind the fixed-income security helps explain the continuous expansion the market has seen as it recorded $263 billion USD in new issuance in 2019 (CNBC. February 2020). Moody’s expects the market to see new issuance of $375 billion USD for 2020 which would raise the market’s overall valuation past a trillion for the first time ever. The rising prevalence of environmental consciousness in decisions nowadays has made investors turn to green bonds over classical counterparts for the potential deed of ethical investing. In addition, we see many of the current investors hold other incentives as well. Institutional investors from pension funds and insurance firms are more willing to invest in green bonds to avoid potential short-term and long-term carbon risks.
Issuance of green bonds are also synergetic opportunities that can help individuals and firms diversify. Socially Responsible Investing (SRI) funds target green bonds as ideal instruments in upholding their unique strategy and values. Firms who may even be renowned for their focus on carbon-intensive energy production - those least likely to garner the acceptance of certain individuals and SRI funds - can infiltrate into the green bond market as a method to diversify their portfolio as well as to attract new investors.
Although it has seen significant positive valuation and endorsement to date, green bonds have obstacles and relative adjustments needed to foster the necessary growth. Empirical asset pricing literature has found that the ownership of green bonds are much more heavily concentrated among fewer investors than the classical counterparts. This can be explained by the fact that green bonds are typically sold at a premium in the market while returning lower yields (by several basis points). This is primarily due to how young this instrument is as well as the capital-intensive costs behind the projects for which green bonds fund. And although financial returns are lower in green bonds, the environmental returns show that green bond investors hold different priorities. Adjustments leading to further growth can help push new investors to share the mindset of valuing environmental returns higher than financial returns (Baker, Bergstresser, Serafeim, Wurgler. January 2019).
Another drawback regards definition. A green bond’s motive and existence are its only defining feature. Even with exemplary growth, the green bond lacks an official label standard that ensures environmental and financial integrity. This causes disruption in transparency and communication among players while potentially harming the market’s future growth. The potential for “greenwashing” is an area of high concern. In 2014, GDF Suez issued the EUR 2.5 billion green bond aimed to finance renewable energy projects. The main project at hand was a hydropower project in Brazil that would harm the environment more than it would help. Thus, to further foster growth and effectiveness, the green bonds market must enforce information transparency criteria and develop an official “green” label (Shishlov, Morel, Cochran. June 2016).
These necessary developments may progress from government intervention. As individuals and firms transit to environmentally sustainable mindsets, governments must take a lead in the conversion to clean energy and preserving the Earth. Many nations have subsidized infrastructure for such projects (i.e. individuals adding solar panels to their homes based on solar capability). Had it not been for the subsidies and tax cuts, the amount of wind and solar farms around the globe would be non-existent due to incredible overhead costs. Likewise, governments can intervene to expand the green bonds market via tax credits and lowering borrowing costs so they may compete with classical bonds financially. In addition, government-backed criteria for a “green” label and necessary disclosure of information will enhance effectiveness and efficiency among current and new players in the green bond market. The government intervention recommendations will come at a cost, but it will pay back financially in the long run as the bond market expands its value and investor base. Simultaneously, it is an opportunity for the government to act in the best interest for itself and of financial markets as well as the environment (Harrison, Filkova. October 2019).
References:
Baker, M; Bergstresser, D; Serafeim, G; Wurgler, J. Financing the Response to Climate Change: The Pricing and Ownership of U.S. Green Bonds. NBER. January 5, 2019.
Harrison, C & Filkova, M. Green Bond Pricing in the Primary Market January-June 2019, Climate Bonds Initiative. October 2019
N.A. Global Green Bond Issuance seen at $300-$375 bln this year-research. CNBC. February 5, 2020.
Shishlov, I; Morel, R; Cochran, I. Beyond transparency: unlocking the full potential June 2016 of green bonds. Institute for Climate Economics. June 2016.
