By Graham Sinclair @ESGarchitect
Nada. Nothing. Zero. Nothing happened a couple weeks ago, and that made headlines. The U.S. Fed blinked. Ms Yellen and her peers chose not to raise interest rates from the current level of close-to-zero where they’ve been held for years trying to re-inflate the U.S. economy after the Great Recession. Your repayments on your student loan, credit card, car or house stayed as they were. One U.S. Fed governor said the news “discomforted the market, but otherwise as the news broke, investors went back about their business making money in an era when money is free and any yield is worth chasing. Venture capitalists are even throwing so much money at startups someone is going to get hurt: there are not enough “unicorns.” Unicorns are start-ups that will reach a $1B valuation and big wins are a must for investors in the highly risky venture capital game. Like barflies at 5 minutes to closing time, investors everywhere are nervous about the Fed turning off the tap, however slightly.
So do low interest rates explain why green bonds are selling for 20bps (.20%) over market rates? That’s a big deal in fixed income land. Barclays was reported by Bloomberg saying “Sales of “green bonds” have been increasing, but so have their prices.” It may be that the case for investing in the underlying assets – solar, wind, green infrastructure – is so strong that investors are willing to pay the green premium. Clearly that is one driver, as Wednesday’s @Triplepundit + @Novozymes #Twitchat #NzymCOP21 explored. The limited supply of fixed income instruments with the “green bonds” label is boosting their value.
Green Bonds: 3x Annual Market Growth
To be clear, green bonds are the Teslas of the fixed income marketplace. ClimateBonds.net reports the “labelled” green bonds market continues to grow (to $70B at September 2015), with the first green bonds from India, Brazil, and China. Standard & Poor’s in March said China’s entry into green bonds market would be a “game-changer.” The growth rate has been impressive. According to the Climate Bonds Initiative (CBI), $11B in green bonds were issued in 2013 (that’s 3x 2012) and nearly $37B were issued in 2014 (that’s 3x 2013). Another 3x growth is predicted for 2015 to $100B. Well, unless you read the WSJ headlines in June 2015, “‘Green Bond’ Sales Struggle.”
The green bonds market came into being in 2008 with the help of multilateral banks such as the World Bank in partnership with Skandinaviska Enskilda Banken for pension funds in Northern Europe. Labelled green bonds enable capital-raising and investment for new and existing projects with environmental benefits. Practitioners continue to seek standards that can scale; currently issuers apply the voluntary Green Bond Principles. Critiques of labelled green bonds include:
- Are these green bonds “additional”? That is, do they finance projects that would not be funded otherwise?
- How green are green bonds? The verification of the actual environmental benefits may be lacking. While acknowledging “All green bonds are investment grade; many have been two or three times oversubscribed,” The Economist in 2014 wondered “what makes a green bond grow?”
The green bond market, like any niche, is prone to bubbles as increased demand meets limited supply. Barclays analysts argue that investors have been paying an extra 20 basis points for “that warm and fuzzy feeling of being environmentally friendly” while questioning the environmental credentials of the underlying investment. As with so many products in the sustainability realm, heightened expectations mean increased scrutiny of the underlying.
Are the green bonds green enough? In Canada, TELUS’ real estate partnership issued its first green bonds to finance TELUS Garden, their new headquarters in Vancouver, British Columbia. But is the ongoing monitoring of green bonds’ underlying holdings transparent? Will tracking metrics ensure it is green enough? As the CFA Institute’s Usman Hayat points out, green bonds can be issued by any old grey company. As with so many of the moves to better value social capital and natural capital in the past decades, it is up to the first movers and activists to shape the field. Voluntary “Green Bond Principles” map a process but no standards. With the growing demand for a clear definition in green bonds, the World Bank issued a green bonds impact report in July 2015.
What’s in a green bond?
Why should companies and citizens care? Well because marginal green projects that need financing can tap this stream of money.
The majority of labelled green bonds proceeds are financing renewable energy or energy efficiency (in Buildings and Industry). Defined more broadly, climate-aligned bonds universe is $597.7B in 2015, estimated by Climate Bonds Initiative by sizing the unlabelled climate-aligned bond market and the labelled green bond market. The 20 percent increase from 2014 is largely attributed to the rapid growth of the green bond market accounting for almost a third ($95B) of 2015’s increase.
The growth in size of labelled green bond market is also driving an increased diversity of the underlying projects including corporate issuance in waste and transport sectors, U.S. municipal green issuance, the first green covered bond issues and more high yield green bonds.
Toyota issued the auto industry’s first-ever Asset-Backed Green Bond in 2014 and dipped back in for $3.5B in 2015 with Citi/BofA/Merrill Lynch/Credit Agricole, and committed to use the proceeds of the Green Bond toward the purchase of retail finance contracts and lease contracts for Toyota and Lexus vehicles that met self-described “high green standards.”
Are the big banks getting in the business of green bonds? Yes, rapidly. When clients demanded some of that good green stuff they had no product. With their New York skyscraper with floors of fixed income analysts, marketers and a pipeline of corporate clients wanting to be banked, the firm turned around and rolled out green bonds within a year.
Municipal bonds are beloved of investors because of their tax-preferred status. So cities looking to green their future have dipped into green bonds. Even beleaguered growing cities like Johannesburg, South Africa is touting oversubscribed green bond infrastructure issuances. Massachusetts claims their 2013 offering of a 20-year $100M issue was the first green bond in the U.S. A new A-rated (investment grade) green bond for SolarCity underwritten by Bank of America Merrill Lynch for solar assets raised $123M. According to Bloomberg, the green bonds has often been pitched to investors as “carrying the same prices as conventional bonds that do not come with a green label.”
Does COP21 mean bigger green bonds?
Heading into COP21 in Paris, investors are calling for clarity on the price of pollution, and who exactly will pay. Initiatives like Climate Bonds Initiative by Sean Kidney have helped grow the market, and deserve our respect for their work. One positive outcome from COP21 may be increased demand for investment products like green bonds. Research by 2 Degrees Investing Initiative suggests the strategic asset allocation of portfolios will need adjusting. Norway’s Oslo Bors stock exchange is the first to separately list green bonds.
The financing for green projects needs to grow hugely, and green bonds are a big part of the opportunity. The International Energy Agency (IEA) estimates that at least $53 trillion (T) must be invested over the next 20 years in renewable energy and energy-efficiency projects and that meeting this goal will require an additional $1T a year in additional investment.
Most interestingly, the IFC and 3 banks are scoping “an innovative new Rainforest Bond.” Whether investors care about the green label or not, in this low rate environment investors will take any decent yield. They may even pay a premium.
While it waits for the Fed’s inevitable interest rate rise, the fixed income market works, inefficiently. This time the environment-friendly financiers make a little extra. Let’s hope it goes to financing “additionally” of that extra wind turbine, Tesla, or rainforest.