Beware. The Green bond market is being greenwashed. But not in the way you think. And not by the people you think are doing it. If participants want the market to continue to be self-regulated, ICMA needs to get tough. If not – and I say this with considerable hesitation – call in the regulators.
Since I posted my “Acquisition finance is not Green” commentary (advocating restrictions on the use of the GB label) I’ve received a fair amount of feedback.
Most preferred to sit under the cloak of anonymity, but thanks in particular to Aaron Franklin, a capital markets lawyer at Latham & Watkins (see his response to my commentary here); Nathalie Rodes, a senior independent credit analyst specialising in Green bonds; and Simon Ingram, head of environmental markets at GreenCollar, the Sydney-based natural resource and environmental services advisory firm. The latter two posted comments in response to the public conversation I initiated with the LinkedIn Green bond group.
No point in beating about the bush here: I think the Green bond market is greenwashing itself into a corner.
In their quest to show that the market is growing and to create a constant flow of self-serving spin, investment banks, second-opinion providers and other key involved parties have pushed the boundaries of definitional elasticity to breaking point. The very people tasked with protecting the credibility of the labelled GB market and the spirit of the Green Bond Principles risk undermining both.
It’s high time those tasked with building out the market move on from wanting to encourage issuers to tap the market by supporting lax standards and focus on setting clear and proper rules. It’s no good saying investors can conduct their own due diligence and decide for themselves on shades of green. That may be true but it’s a cop-out and a poor collective excuse. And if that’s the case there is simply no point in having a labelled market at all. Shut it down now and let’s all switch our attention to the unlabelled climate bond universe.
The pressure is on ICMA to come up with a much more stringent set of guidelines. The market-practices body will be unveiling its update to the Green Bond Principles on June 16 and I gather they’re going to be tighter than the existing set. They need to be. Its six working groups (covering assurance, databases and indices, project categories and taxonomies, impact reporting, new markets and social bond principles) have provided input to the updated GBP. Let’s see how they turn out.
Big-Tent Approach
In his response to my original commentary, Aaron Franklin, like many others in the market, advocates the ’big-tent’ approach to labelled GB market inclusion. He believes it will lead to “more deals that include promises of good environmental and social behaviour, more attention to environmental impact and more focus from the investment community on these topics”.
I agree that it may lead to more deals but of what environmental quality? The Green bond label has to equate to a formal and structured engagement with the climate change mitigation agenda. As a visible sign of environmental commitment that actually means something, the label has to be hard to obtain and seen in the same light as an ISO quality assurance label.
Set the standards high. If companies genuinely want to garner positive benefits for themselves and the green economy, they will aspire to meeting those standards. Set the standards low and companies lose that key value differentiator.
The GB market has to be more than a ‘me-too’ market. Maintaining stringent standards may lead to fewer deals but at least you should be able to guarantee that those that do get the label transcend empty marketing or vague statements of intent. The labelled GB market needs to climb the ladder of clear and transparent rules – and yes I mean rules rather than principles. And yes, at the potential expense of huge primary flows into the labelled market.
Mr Franklin thinks it’s unclear what good can come from constricting the definition of Green bonds. The good that can come of it is more clarity and greater certainty. If a bond has that label, you should be able to be certain that you’re going to get transparency at the front-end (specific use and ring-fencing of proceeds; clear project selection criteria) and transparency at the middle and back ends (management of proceeds; reporting; detailed impact assessments).
The Green bond market should not be a pretext for Big Swinging Dicks to brag about size or for corporates to brag about how right-on they are.
Too much spirit, not enough letter
I remain resolute in my baseline position: the voluntary standards are too heavy on aspiration and too light on rules. Too many issues that I and others struggle to see as Green (as in labelled Green) are being forced through the screens. Too many people are getting tied up in the general topic of projecting the green economy and offering investors a route into it instead of focusing on the fundamental importance of building a credible rules-based bond market. It’s macro versus micro.
How can pretty much every Green bond conference still discuss what a Green bond is after so much time has elapsed since the market’s inception? Time to move on.
The desire to attract new issuers and build volume has led GB players to dilute the spirit (if not the letter) of the GBP and lower the barriers to entry to such an extent that I fear the labelled GB market is becoming the ill-defined, slightly bogus market that people have worked so hard to prevent and which the market’s naysayers – and there are many – always said was going to emerge (the ‘I told you so’ brigade). The GB stamp has to be more rigidly protected.
There have to be key differences between a gold-plated use-of-proceeds labelled Green bond market with its stringent eligibility rules, and an unlabelled climate bond market. The burdens of proof, accountability and responsibility for climate bonds can be lower and policing will tend to be driven less by contractual and legal issues and more by reputational issues at the issuer and underwriter end and credibility issuers at the investor end.
Yet the two markets are being conflated thanks to some creative interpretations of the GBP. Whenever I ask questions about unclear green claims, I get the brush-off and that ‘you can’t set the barriers to entry too high otherwise it will deter issuers from accessing the market’ line that’s become so old.
Offering market-access incentives to issuers via low standards, proponents of this approach believe, will encourage companies to place environmental issues front-and-centre of their cultural and governance agendas. Again I disagree. Access to Green funding is unlikely in and of itself to move that particular needle; other much more important drivers are at play there.
These days, you’re either Green or a Has-Been from the perspective of positioning your corporate reputation. Funding is part of that conversation but it’s much more about CSR and employee-engagement; about corporate strategy and driving management and board actions; about driving external IR and PR initiatives and aligning them all in a coherent whole.
So what should ICMA be focusing on?
1 Pure-play
How can anyone say with a straight face that general corporate purpose bonds even issued by pure-play companies – viz Sveaskog, Vestas Wind Systems, Xinjang Goldwind – can be labelled Green bonds – particularly when the market itself was at great pains to exclude such issuance a couple of years back?
This may be a nuanced point given we’re talking about the pure-play space but in the absence of stringent GBP tests, having second-opinion providers give pure-play companies designations that certify everything they do in the capital markets as Green can’t be right. In this regard, I do indeed cast doubt on the validity of many pure-play Green bonds and the second opinions issued in support thereof, as per Aaron Franklin, in the absence of use of proceeds and other tests.
Similarly, bonds issued by companies whose new issues gain the Green imprimatur from second-opinion providers by dint of pre-existing boilerplate green frameworks but which fail to meet the specificities of the GBP for the new debt need to be questioned.
2 New vs Existing Assets
On the question of new vs existing assets, I continue to believe strongly that the key driver of the GB market should be transparent and carefully monitored financing of new green projects. That’s where the rubber really hits the road. But if the market insists on keeping a place in the labelled GB tent for refinancing existing assets – and it does – then it’s arguably down to how you account for refi in Green datasets.
Refis should be tagged and flagged separately from new GB investments and if a new bond does both, as many do, issuers should provide granular dollar-for-dollar use of proceeds breakdowns. I’ll be taking this issue up with the database working group that ICMA recently convened. It’s partially an issue of dealing with multiple-counting and proper market sizing.
If a company issues a bond to redeem outstanding Green debt, can the new bond really be Green in the way that most people would understand the term and as the GBP were framed?
If I issue a US$100m bond to fund my green asset pool and refinance it through the bond market every year for 10 years, have I invested US$1bn in the green economy? In absolute terms, I guess the answer is yes. But at so many levels it’s disingenuous to frame it that way. If I told 100 people I’d invested US$1bn in the green economy over the past 10 years, I doubt the majority of those people would accept churning the financing of my small green asset pool nine times as valid.
In arguing that the inclusion of a mix of new and existing assets is acceptable to support the market’s development, especially on the corporate side (on the basis that the main GB investors are financial institutions that favour large-scale issuance to manage liquidity risk so issuers need to present sizable portfolios to enter the market), Nathalie Rodes introduced the issue of whether issuers have sufficient new eligible projects to reach the critical size to tap the capital markets. Interesting point.
I’m not sure I like the idea of engineering GB market activity to meet the size requirements of big investors (it’s a bit backwards-on) in the absence of new projects, but I say if corporates can’t find eligible projects, let the GB market be capped at the size of available eligible projects. And let the burden then shift to corporates to build out their project scope, maybe under the umbrella of COP 21 outputs.
3 M&A
Bonds issued to refinance loans taken out to fund pure-play corporate takeovers must be excluded from the labelled GB universe. Nathalie Rodes says GB “aim to finance the transition to a low carbon economy and financing the consolidation of two green tech companies to ease the development of their future green activities is part of this scope”. I disagree. That’s just too general a point. M&A is beyond the scope of the labelled GB market and is too much of a stretch for the GBP.
Aaron Franklin says “acquisitions shape the incentives that lead to early-stage investors taking a risk on new green businesses … there is no telling how many fewer green businesses we would have without this possibility”.
Again, that’s a perfectly fine point looked at from the perspective of creating access points for investors into the green economy. But that’s not the point here and fails to capture the essence of what the labelled GB market should represent.
The Green Bond community needs to take a step back and disentangle emotional issues around climate change from the hard-core of proper rules for a labelled GB market.
Either the market brings in a heavily reinforced self-regulatory model – witness ISDA’s interaction with the OTC derivatives market – or the only recourse will be to call in the regulators and have the market succumb to a set of black-and-white rules. With their enforcement costs and the punitive downsides of non-adherence.
Market participants say regulation is a step too far. Well if that’s the case, ICMA needs to wrest control of the market back from vested interests in the GB ecosystem, establish some legitimacy away from those that have assumed it in the absence of proper market leadership, and get tough in the market’s long-term interests.
Maybe it’s time for ICMA to ditch the Principles and the softly-softly approach, take a leaf out of ISDA’s book and draw up a formal and binding Green Bond Master Agreement. Thoughts?
