Green Bonds

Green Bonds

By: Phil Kernen

Making decisions that help the environment, as well as your bank account, has never been simpler. Investing through an ESG lens, considering the Environmental, Social, and Governance impacts of an organization, has exploded in the minds of the investing public. Doing so makes it easier than ever to identify companies making a difference in combating climate change and meet related challenges. Most options, however, have been limited to buying stock in those companies. The availability of a different choice has been slowly growing.

Green bonds have existed for over a decade, issued by governments and corporations to fund environmental objectives. Renewable power projects received most initial proceeds, but transitioning factories, power grids, and office buildings to clean technology are now claiming a bigger slice. Borrowers must certify that the deal proceeds go to such goals, and an entire industry has arisen to help to do that.

Demand was initially weak, so green bonds often sold at lower prices, which meant it cost more to borrow. It was mostly a feel-good exercise for issuers and borrowers who wanted to demonstrate positive environmental action. As investors increasingly adopt ESG investing principles, that is changing.

The global green bond market is still tiny, about 1% of the worldwide bond market. It started as and mostly remains a European thing, though the US is the largest national issuer. In 2021, $450 billion of the $30 trillion of bonds issued worldwide were green bonds. With the growing attention devoted to climate change and current green bond growth rates, annual global issuance will exceed $1 trillion by 2023. US participation is growing too, having issued more than $50 billion in 2021, a quarter of which were sold by Fannie Mae, the mortgage purchasing arm of the US government.

The Federal National Mortgage Association, commonly known as Fannie Mae, is the largest US issuer and has cumulatively issued more than $100 billion in green bonds. It used the proceeds to fund energy- and water-related capital improvements at multi-family properties on which it held mortgages. In addition, more and more US companies include green bonds as part of bigger conventional debt issuances.

Pricing has changed too, with a growing body of research suggesting borrowers can save money by issuing green bonds, called a ‘greenium’, instead of conventional bonds. Proponents believe such savings will accelerate green bond issuance further. But the differences are relatively minor, and they vary by geography. Even so, after factoring in costs associated with maintaining compliance with Green Bond Principals and certifying the use of deal proceeds, the overall financial benefits are immaterial. Nevertheless, issuers believe raising their profile in the eyes of environmentally conscious investors is worth the effort.

The desire for positive environmental press leads to another risk endemic to all ESG investments. Greenwashing is the practice of putting more effort and resources into burnishing environmental credibility than into minimizing verifiable impact. For example, with the growth of the European green bond markets, regulators are uncovering more cases of greenwashing by investment managers capitalizing on the growing demand for sustainable finance. Greenwashing is a problem that underscores the difficulty of standardizing what constitutes green finance.

Many jurisdictions lack a clear legal definition of what qualifies as a green bond. European Union regulators have taken small steps while the US Securities Exchange Commission has not taken action. Required disclosures, a part of every security issuance, are not uniform for green bonds. Questions abound. What kind of disclosures are needed? How will disclosures need to differ across asset classes if investors prioritize different outcomes such as changing water usage or reducing carbon footprint? Is the desired data even obtainable?

The accelerating growth rates of green bonds mean they will be a material asset class at some point. But for now, green bonds remain a niche asset class that will make little impact on portfolio returns.

Disclosure: This is for informational purposes only and any reference to a security type does not constitute a recommendation to buy or sell that type of security. The reader should not assume that an investment in the security type identified or described, was or will, be profitable. For a complete list of disclosures, please click https://mitchcap.com/disclosure/

2021-12-31T11:21:59-06:00 December 31st, 2021|ESG Investing, Investment Management|0 Comments

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