Claudia Conway, Journals Editor, RICS/ 29 January 2020
Green bonds are rapidly growing in popularity around the world. Over US$ 230bn worth of bonds were issued globally during 2019 and issuance is expected to reach record levels in 2020. While they have the potential to transform the way green projects are valued and financed, the absence of a common language on what qualifies as “green” is a crucial hinderance.
Green bonds are intended for the financing of sustainability projects, many of which are in the built environment. Yet they are still relatively new to the market, having first been introduced in 2008 after a group of Swedish pension funds contacted the World Bank to ask how they could find investments that would help sustain the environment.
The IMF asks whether this fast-moving and creative market can ensure ‘risks and rates of return are fully transparent, comparable, and accessible in ways that can be consistently monetized’ against a background of change, varying national approaches to sustainability and, of course, intense competition.
The language of green bonds
Every bank active in international capital markets now has staff dedicated to green bonds. Verification and other information services are growing around this market to help supply confidence, but risks and issues still remain – a key problem being whether all the parties concerned are talking the same language around green finance.
Standardisation was a major talking point during the recent WBEF webinar ‘De-risking green finance’, which brought together four experts to discuss the current and future state of the market.
“There are a cacophony of groups, industry associations and regulators trying to establish a common language for the sustainability project”, notes Michael Doran, Partner at law firm Baker McKenzie. With fellow panellists, he discussed the value of the EU taxonomy for sustainable finance (‘a list of economic activities with performance criteria for their contribution to six environmental objectives to create a common language for all actors in the financial system’), in helping to increase confidence that projects funded really are green. RICS played a major role in developing the taxonomy as one of the 35 expert bodies chosen to sit on the working group, sharing its broad experience in the built environment and sustainability.
The EU taxonomy will also assist issuers in their reporting duties. Guidance on this requirement is becoming ever stricter to avoid charges of ‘greenwashing’ that could undermine the market. The London Stock Exchange, for example now demands that ‘bonds issued by companies with revenues dominated by green activities will be required to submit annual, verified reports about how the proceeds are being used’.
Katie House verifies green bonds within her role as Analyst at Affirmative Investment Management, and in an increasingly diverse market including real estate, renewable energy and agriculture among others, a standard mode of reporting has great value.
Currently, House is seeing a variety of metrics reported on, without consistency between reports; standards can express that “these are the kinds of metrics that are expected to be reported and these are the things that it would be useful to be reporting. It’s really helpful for us to be able to understand whether the green bonds are delivering the impact we want them to”, she explains.
“Guidance on reporting requirements is becoming ever stricter to avoid charges of ‘greenwashing’ that could undermine the market. The London Stock Exchange, for example now demands that ‘bonds issued by companies with revenues dominated by green activities will be required to submit annual, verified reports about how the proceeds are being used.”
Impact, not greenwash
Green bonds are all about impact – it’s what investors and the public want to see and is increasingly mandated by governments and international agreements. Reporting and understanding how to report appears to be improving. However, concerns remain that green bond contracts lack teeth should the funds be misspent, or issuers fail to report as they should. As long as the issuer continues to service the loan, Doran explains, the investor has no ability to pursue the issuer and may be forced to sell the bond on the secondary market, as they will be in breach of their own investment criteria and have no other redress.
More work is needed to give contracts more bite when requirements are not met, as any such occurrence will dent trust in green finance and slow growth. Sean Kidney, CEO of the Climate Bonds Initiative, warns of the danger of scams if too many incentives are introduced – they must be balanced with regulation in order safeguard against their being taken advantage of.
There is also the matter of whether what issuers are doing is ambitious enough – governments, both individually and collectively, are setting a high bar of achievement in cutting carbon; finance must play its part in reaching these goals. Government regulation and global pacts such as the Paris Agreement and the UN Sustainable Development Goals (SDGs) will all drive the market – the built environment sector needs to “aim big and aim now, not later”, according to Ted Chapman, Senior Director of S&P Global Ratings. Some green bonds are already tying their reporting requirements to the SDGs as a benchmark of what they will achieve.
For individual assets, the conversation has moved beyond whether a building is certified by schemes such as LEED or BREEAM to the actual level of award they have achieved. Merely being green is not enough; there needs to be evidence to compare assets to one another. Better labelling of buildings to understand their efficiency levels could be a significant incentive to investors. Says Kidney: “the biggest barrier in every economy we go into is the lack of easily available universal labelling schemes”.
“The market faces the handicap of a short history and therefore less data than better established areas, and a perception that green finance is more costly than other forms of finance.”
Beyond cost and comparables
At base, there is always the concern of how much green finance costs and what can be judged through comparables. The market faces the handicap of a short history and therefore less data than better established areas, and a perception that it is more costly than other forms of finance. The reporting requirements may seem onerous to some, but Kidney claims that “cost is overblown” and the corporate sector has been pleasantly surprised once they have dipped their toes in the waters of financing sustainability, with some issuers in liquid markets finding they get sufficient price benefit to cover their costs or more. Some need to overcome the ‘fear factor’ of reporting and see how they can benefit – there is also a need to ensure that reporting requirements are kept simple but effective in order to encourage take-up and competitiveness.
If comparables are lacking, perhaps the best argument for green finance is not to look at the past, but to consider the future in light of existing data and projections on climate change, and the impact this will have on assets.
While the initial focus in built environment sustainability was on greenhouse gas emissions, it is now moving towards building performance and efficiency, from mitigation to resilience. This move also underlies perhaps the most significant driver of green finance in real estate – with events such as Australia’s disastrous bush fires and increasingly frequent and severe flooding in cities, investors are now fully alive to the fact that assets are at physical risk from climate change if they are not resilient. Above all, investors want their capital to be protected, and it is protection rather than yield that green finance is about. Green finance will be essential in providing cities with buildings and infrastructure capable of withstanding environmental shocks. In doing so, they promise to protect the trillions of dollars invested globally in the built environment.