Australian fixed-income investors interested in the global market for green bonds – estimated to be worth well in excess of USD100 billion and growing – should take care when considering buying them, says global asset manager AllianceBernstein (AB).
“One of the key questions investors will need to ask is, ‘What exactly constitutes a green bond?’” says Erin Bigley, the firm’s New York-based senior portfolio manager – fixed income.
A number of incidents have highlighted the need for transparency for a bond’s green credentials, particularly with regard to how the proceeds of an issue are to be spent.
“Last year in the US, for example, there was the case of a state college which issued green bonds to fund the construction of a 725-space car park – hardly, on the face of it, an environmentally friendly project,” says Bigley.
The green-bond funding of a hydropower plant in Brazil was called into question when activists claimed that the project could endanger fish species and lead to more deforestation.
China, which this year became the biggest source geographically of green bond issuance, considers clean coal to be an eligible “green” project, contrary to most environmentalists’ thinking.
At the opposite end of the spectrum, Mexico City Airport Trust successfully financed an airport – infrastructure typically regarded as a major polluter – with USD2 billion of green bonds because the new facility is intended to be 100 per cent carbon neutral.
Bigley noted the emergence of a number of new bodies, such as the Climate Bond Initiative, to provide certification for green bond issuers. Traditional credit rating agencies such as Standard & Poor’s and Moody’s Investors Service are developing their own verification methodologies.
Ultimately, however, investors need to apply the old maxim caveat emptor, or “buyer beware”, says Bigley.
“While these various agencies may to some extent help investors make a purchasing decision, the differences between them in terms of verification criteria and methodologies may also create the potential for confusion.
“Ultimately, investors face the challenge of deciding for themselves whether a green bond has all the right green credentials as well as credit characteristics.”
Bigley lists four steps that investors could take to help them decide whether or not to buy a particular green bond: “Firstly, be happy with the underlying credit: the borrower’s ability and willingness to pay, not its green credentials, should be the final arbiter of whether or not the bond is put into a portfolio.
“Secondly, if possible, meet issuers face-to-face before buying their bonds to assess what they mean by ‘green bonds’ and whether their interpretation is acceptable.
“Thirdly, give preference to green bonds that have an individual verifier (such as CBI, Moody’s, S&P etc.) but take into account any particular idiosyncrasy of approach that the verifier might have.
“And finally, review all green bond holdings to ensure that the issuers have applied the proceeds of their issues as they said they would. This information should be reported annually; if any issuer fails to do so, investors should ask them why not.
“These are not the only considerations for green-bond investors – others are related to portfolio construction and allocation, and how green bonds should be priced – but they are among the most important for anyone entering this increasingly interesting and sophisticated market.”