Green bonds: Is it green finance or green-washing?

The green bond market has been gaining traction since its inception in 2007-08. According to Climate Bond Initiative’s green bond market summary, global green bond issuance reached $167.3 billion (INR 13,000 billion) in 2018 (Market Summary, 2018).

As opposed to traditional / vanilla bonds, green bonds are issued to finance or refinance investments in ‘green’ projects such as renewables, water and energy efficiency, bioenergy and low carbon transports.

Green bonds have been issued by multilateral institutions such as the World Bank, private companies, national and local government institutions so far. Proceeds from green bonds have been utilised for meeting the climate ambitions in various countries.

For instance, solar voltaic systems financed by World Bank green bonds helped to electrify rural households in Mexico and Peru. In Jamaica, the Energy Security and Efficiency Enhancement Project facilitated investments through green bonds to create wind farms, solar farms and a hydro plant.

Yet, investors have traditionally been wary of investing in these instruments. One of the main hurdles to a green bond boom in financial markets is the risk of ‘greenwashing’. A term coined by environmentalist Jay Westerveld in 1986, greenwashing is the practice of channeling proceeds from green bonds towards projects or activities having negligible or negative environmental benefits.

Greenwashing brings significant reputational risk for socially conscious investors seeking to diversify their investment portfolios by investing in environmental, social and governance practices.

Some of the controversial incidents include a green bond issuance by the operator of the Three Gorges Corp in China, which has been routinely criticised for polluting water and damaging the surrounding ecosystems.

In another instance, green bonds were issued by GDF Suez in 2014 for financing the Jirau Dam in Brazil, and which led to the flooding of a rainforest.

In an effort to promote the integrity of the green bond market, the International Capital Market Association developed the Green Bond Principles (GBP) in 2014 providing voluntary guidelines for the market’s broad usage, including principles regarding the use of proceeds, process for project evaluation, the selection, management of proceeds and reporting for green bond issuances.

In doing so, while refraining from providing an explicit list of ‘green projects’, it provides guidance by way of an inclusive list of potential green projects.

Additionally, the Climate Bonds Initiative has launched the Climate Bonds Standard and Certification Scheme to provide certification and credentials to green bonds by specifying eligibility criteria for projects to be financed by green bonds alongside providing a climate bonds taxonomy.

While the infrastructure for green bond issuances is, to a large extent, in place in developed countries, developing countries are yet to jump on the green bandwagon. According to the Market Summary, 2018, emerging markets accounted for only $40 billion of green bond volume in 2018, or around a fifth of the issuance.

Coming up of green bonds in emerging economies such as India and China is undeniably crucial for this market’s growth, especially since a larger chunk of climate investments and infrastructure is required in these very countries.

Emerging economies have attempted to model their own national guidelines for green bond issuances. In India, while defining permissible end-uses for ‘green debt securities’, Securities and Exchange Board of India’s guidelines on the issuance and listing of green debt provides broad projects / assets in line with the GBP.

National regulations on green bonds, however, have also posed their own challenges. When the People’s Republic of China released its ‘Green Projects Catalogue’ in 2015, it included ‘clean coal’ as a permissible use of proceeds for Chinese green bonds (now proposed to be removed), which is specifically barred under the European Union taxonomy.

There are various institutional and market barriers to the development of a sophisticated green bond market in emerging economies. Given that a pre-requisite to the green bond issuance process is the existence of technical knowledge of existing international practices in green bond transactions, inadequate knowledge has driven issuers and investors away from these instruments.

Apart from institutional barriers, market barriers pertaining to the issue of minimum size, currency risks and high transaction costs have further driven emerging economies from embracing this instrument. As a result, small-scale green projects in developing countries have been unable to tap the international financial green bond market.

One of the foremost requirements is to harmonise international and domestic guidelines and standards for green bonds to develop a robust green bond market. Homogeneity is also required in terms of what constitutes green investments, as varied taxonomies would be antithetical to a cross-border green bond market.

In defining green projects, it may be worthwhile to include ‘negative lists’, in order to explicitly exclude investment in fossil fuels and other activities / sectors which are not climate friendly. Eligibility criteria, including climate-focused negative lists, would supplement efforts to filter investment in GHG emitting sectors, and may be periodically revised based on scientific findings for the Paris Agreement pathway.

Streamlining the green project taxonomy may address the greenwashing risk, and at the same time, could help foreign investors in avoiding high transaction costs.

Apart from standardisation, ratings by credit rating agencies could help in providing external reviews of green bonds, and bring credibility to the system. Green bond standards and indexes have already been initiated by rating agencies, such as Moody’s.

Appropriate capacity building efforts for issuers in emerging markets to spread knowledge on the benefits and related processes and procedures pertaining to green bonds, would help in addressing the institutional barriers to entry into this market. In terms of the market barriers, collaborative efforts by governments, investors and development banks could help in bringing more accessibility to these instruments.

Involvement of the public sector in scaling up the momentum of green investments is crucial. In the context of green bonds, strategic public sector investment could help in attracting private investment as well as inspire investor confidence in the green bond market overall.

Further, institutional investors such as pension funds and insurance companies can help in bridging the gap where traditional sources of public and private funds have proven to be insufficient to provide the required climate investment needs.

In 2017, the Organisation for Economic Co-operation and Development (OECD) estimated that $6.9 trillion is required annually until 2030 to meet the climate and low-emission objectives. According to another OECD estimate, bonds for low-carbon investments in the renewable energy, energy efficiency and low-emission vehicle sectors have the potential to scale to around $700 billion in annual issuance in China, Japan, the United States and EU by 2030.

In view of the above, and at a time when developed countries have committed to mobilize $100 billion annually to meet the collective climate goals of the Paris Agreement, it is imperative to adopt new and innovative ways to channel climate finance to vulnerable countries.

Green bonds may just be one of the means towards that end.

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