When Rob Fernandez analyzes potential investments for
clients, he looks at what exactly it means for an
investment to be green.
We won't just buy a green labelled bond for clients just
because it says it's green.
More and more investors are interested in putting their
money to work in a way that will help combat the climate crisis.
And green bonds are the poster child of this kind of financing.
Environmental, social, and governance issues are here and
it matters.
And some big household names are getting into this space, like
Apple, Pepsi, the New York MTA. Plus, a handful of massive
banks. Not to mention governments around the world,
like China, Russia, the EU and and more. This kind of bond
issuance may top $650 billion in 2021. That's about eight to 10%
of all the bonds being issued around the world.
They're a growing part of the marketplace. They're going to
continue to grow. And I think that's going to be a major part
of the bond market.
So, there's a whole new bond market within the bond market.
Bonds as we know them work like this: An issuer, most often a
company or a government, raises money by offering bonds to
investors. They're basically IOUs, an exchange for getting
money up front, when you sell the bond, you pay the bond
holder back over a certain amount of time with interest.
Issuers use these bonds to raise money to invest in their
business, employees, infrastructure, anything you
name it.But green bonds are different.
The fundamental differences that it's about what it's financing,
first and foremost.
Money raised from these are earmarked for projects that are
positive for the environment.
The one key difference is that the issuer makes a non-binding
voluntary commitment to earmark the proceeds and use them for
specific environmentally-friendly
projects. So, it could be renewable energy, energy
efficient buildings, clean transportation, clean water, but
from a structure standpoint, they tend to be the same as the
traditional bonds that issuer would bring to market, minus the
green commitment.
The market here is bigger than just green bonds.
So, we saw last year about $490 billion of green, social and
sustainability bonds combined. This year, we're expecting about
$650 billion across those three categories.
And that's up 32% from 2020.
So, it's really it just keeps going.
Sustainable bonds break out into three categories: Green, social,
and sustainability.
Social bonds would be used primarily for social purposes.
It could be affordable housing, or micro finance.
And the sustainability bond category here basically means a
bond meets both green and social standards of issuance. The
biggest slice of the pie goes to green bonds with an expected
$375 billion of issuance in 2021.
In 2020, green bonds reached about $1 trillion USD at the end
of 2019.
And issuance is growing.
So it's a huge diverse mix. Banks, corporates and
governments. Anyone issuing or the ability to issue a bond is
issuing, especially when they have the eligible assets to do
so.
Most issuances so far have been considered investment grade.
That means independent rating agencies say those issuers are
most likely to repay their debts. The other side of the
bond market is more risky, often called high yield bonds or even
junk bonds. As for the buyers...
The buyers are the big pensions, the big asset managers. They are
the guys that really are putting pressure around the need for
more green investments. Retail investors are having a chance to
invest in muni green bonds, and that's not a common practice
that's happening globally.
I think that's going to be a major part of the bond market
where the retail investor can get some participation in that.
When it comes to accountability...
To date, it's been largely, you know, sort of a best practice,
document-driven market. But at this point, it's been a
regulatory light market for the most part. The green bond
principles, which are sort of a best practice document that was
put out by the International Capital Market Association.
For a green labeled bond, if the issuer is complying with the
principles, the green bond principles, then there's certain
parameters, certain guidelines they have to follow.
There's four core requirements that these bonds must meet, but
it's a non-binding voluntary commitment. First is use of
proceeds. It's basically the legal document that details how
the money raised will be used for green projects. And to
determine what's green, there's what's called a taxonomy.
The taxonomy's main objective is to help set the course on what
is green. You know, think of it as a dictionary or catalog of
what we mean by green.
The other core components include process for project
valuation and selection, management of proceeds, and
reporting. They're all interconnected. And essentially,
it advises issuers to keep up-to-date information on how
the money is being used and the project's environmental impact.
How are you going to manage the proceeds during the time of the
bond, you're going to use a tracking system or you're going
to ring-fence it, the proceeds? And of course, how will you
report on those is really the fundamentals on what the green
bond principles is trying to lay out.
All of this can be subject to second party opinions, external
reviews, and even verifications and certifications.
It's not one of the four key principles, but it's like it's
essentially a fifth and many issuers are doing it. And then
they'll oftentimes will bring an external reviewer in to provide
an opinion on the credentials of the offering and whether it
aligns with either the green bond principles.
And that's what investors actually rely on. They rely on
that verification that second party opinion, or certification
of the green bond.
Think of those stamps you may see on coffee or paper towels,
even ice cream, that are meant to signify to buyers that
whatever they're buying is ethical or sustainable.
When we pick up a product in the supermarket, and we make a
decision on whether we buy the same product, but of a different
brand, if one has been, you know, stamped by WWF or
Rainforest Alliance, we have a tendency to go, "I trust that
label." It is a marketing component that comes with an
assurance behind it that you can buy this product and know that
the due diligence has been done.
But issuers don't have to do this.
Well, investors in the U.S. market are gonna buy muni bonds,
whether they're green, or whether they're purple, or
whether they're pink. There is no guarantee what is being put
out actually is green.
Some muni bonds are getting that external review.
And so for example, like the New York MTA, they've issued green
bonds, and they've received a second party opinion.
They definitely wanted that extra credibility that it was
somebody else credible, authoritative voice saying that
this was green, not the MTA.
If the issuer decides to use all the money raised for something
else, there's no regulation in place to punish them.
Typically, we haven't seen sort of legal repercussions and bond
documents that say if the funds aren't used for specific
purposes, that it will be an event of default. So it's really
been, you know, what sort of the reputational impact there could
be.
It's why the rules of the game becomes so important and making
sure we have the right standard frameworks and verifications
happening.
Yeah, what's next for the sustainable green bond market? I
do think we're gonna see continue to issuance.
Plus, the market is evolving to include sustainability-linked
loans or bonds.
The interest rate is typically tied to the achievement of some
sort of sustainability target, the coupon could step up by 25
basis points, for example, if a targets not hit some point into
into the life of the bond.
It's almost as they're setting themselves up that they could
have a financial penalty, should they not achieve their goals.
So, there's only been about $15 to $20 billion of
sustainability-linked bonds to date, but the vast majority of
that has been in the last six months or so. So, a lot of
growth potential there, just still very early stages to kind
of size the market.
And we'll also see a rise in different labeled products
Like blue bonds or gender bonds
Blue bonds have been issued as a way to look at marine projects
or ocean or water projects. We've seen some gender bonds.
This is really looking at diversifying gender on boards or
in the workplace.
There was a big U.S. Bank last year that came to market with a
social bond they called a racial equity bond. You could see the
green, you know, the green label being used by issuers to support
the infrastructure spending from the Biden administration plan.
And therefore green bonds serves as a extremely useful tool in
moving large amounts of capital towards those projects, and
encourages, obviously this need to think about building out the
infrastructure that is going to prepare the United States for
the impacts of climate.
The only thing that's constant is change. And, so when you se
this new wave of green bonds and these topics arise on th
environmental social governanc side, it's great. It's great t
see that the growth is there an people are actually payin
attention to these details