High levels of green bond issuance have sparked investor interest and spawned funds and strategies, writes Rachel Fixsen

At a glance

• Green bond issuance surged last year with $81bn of new bonds.
• A first green bond ETF was launched this year and asset managers creating more new products.
• Greater transparency and standards in the sector reduces risk of greenwashing.

The surge in the green bond market over the last year has been a boon for government and corporate issuers, and could bring the instruments further into mainstream investment territory for institutional investors seeking to shrink their carbon footprints.

Since they were first issued 10 years ago, green bonds – whose issue proceeds are tied to environmentally-friendly activities – have broadened both in terms of issuers and their underlying financing purposes. And with asset managers creating an increasing number of new products investing in them, green bonds seem to be becoming more accessible for investors.

In January, France became the first euro-zone sovereign to issue a green bond, and the €7bn 22-year debt attracted big institutional backers including Dutch asset managers APG, PGGM, and MN, as well as French pension funds ERAFP and Ircantec.

Several of Sweden’s AP national pension funds have announced plans to increase their investments in green bonds in the last year, and in February, the country’s largest pension fund, Alecta, said its green bond investments had grown to SEK10bn (€1bn).

Concerns about the credibility of green bonds have been allayed to some extent by the  standards that have been established by various bodies such as the Green Bond Principles (GBP), created at the beginning of 2014 by a group of investment banks.

“Greenwashing is a risk, but standards are improving and there is now better transparency in the sector,” says Sarika Goel, research specialist for responsible investment at Mercer.

The principles, which are supported and administered by the International Capital Market Association (ICMA), aim to encourage transparency, disclosure and integrity in the development of the green bond market. The Climate Bonds Initiative runs the Climate Bonds Standard as a Fair Trade-style label for bond issues, and firms such as ESG research and analysis provider Sustainalytics also play a role by independently reviewing bonds.

Lyxor Asset Management has recently launched the first green bond exchange-traded fund (ETF). “We couldn’t have done it before, because the level of debt was too low, but now it has grown to $200bn (€187bn), we have sufficient basis of liquidity,” says François Millet, product specialist at Lyxor.

where the money goes green bond proceeds by sector 2016

Last year, some $81bn of green bonds were issued, and with $27bn coming to market by the end of March this year, Millet says 2017 issuance is on track to reach $120bn. This would bring the total market for the instruments to $260bn at the end of 2017, he says, given the redemptions that will happen in the meantime. 

“With the ETF, we are addressing a new category of investors: tier-two investors, such as private banks and wealth managers,” Millet says. Institutional investors need to find instruments where they will have assurance that the proceeds will be directed towards activities combatting climate change, he says. “This is a very powerful force now for institutional investors in Europe after the Paris conference.” 

The Paris climate change agreement in December 2015 created a watershed in green finance, with one of the pact’s core aims being to put financial flows in place to reach the goals of keeping a global temperature rise this century well below two degrees Celsius – and to try to limit it to 1.5 degrees above pre-industrial levels.

While there is a first group of conviction-led investors who need to find pathways into sustainable investment, a second group is being pushed to do so by imminent regulation in the area, says Millet.

The Task Force on Climate-related Financial Disclosures (TCFD), chaired by Michael Bloomberg, is currently working on a set of recommendations for effective disclosure of climate-related financial risks, and is set to present them to G20 Leaders ahead of July’s Hamburg summit.

Meanwhile, France’s energy transition law sets out a road map to mitigate climate change, focusing on carbon reporting that applies to all investors. While green bonds have become popular as investments, particularly in the light of the strong growth in the market seen last year, Goel cautions that the sector is still very small. 

“It’s too early to say whether these are good investments for pension funds without doing the due diligence,” she says. “We have seen very few dedicated green bond strategies, and there has been a lot of discussion about exactly what a green bond is.”  

However, Mercer has observed some pension funds have been broadening fixed income mandates in this direction in another way. “Some pension funds have been saying to their managers that where they do select bonds, all else equal, they would prefer these to be green bonds,” says Kate Brett, principal for responsible investment at the firm.

Goel says there is no set standard yet on asset managers measuring the impact of their ESG investments, including green bonds, but metrics such as carbon emissions avoided are being used. 

While measuring the carbon footprint of an equity portfolio is becoming standardised, Brett points out that the exercise is less so for bonds: “For equities and corporate bonds more broadly, assessment is at the corporate entity level, but where you have a large company issuing a green bond, they are typically ring-fencing the proceeds for certain business areas, and that’s where you need an additional level of scrutiny.”

Christopher Flensborg, head of climate and sustainable financial solutions at Sweden’s SEB, is one of the pioneers of the green bond market, having been involved in the creation of the first green bond with the World Bank in 2008. The financial group has helped place many green bonds and recently went on to issue its own green bonds with a €500m issue in February.

Flensborg believes the growth in green bonds has a much wider significance for the financial sector than the simple value of the market. “The role of the green bond is to change the dialogue and raise awareness of the financial link between environment and financial performance,” he says. Because they are priced at more or less the same level as other bonds by the same issuers, he adds that investors can find themselves investing in the instruments for primarily financial reasons.

“When institutional money is invested in green bonds, that institution is then forced to increase its analytical capabilities around green issues, so the bond acts as a Trojan horse that makes people define what is green and learn how this relates to traditional financial portfolios,” Flensborg continues.

Mette Charles, senior investment research consultant at Aon Hewitt, says that for most pension funds at this stage, exposure to green bonds is likely to come through externally managed funds rather than from any fund consisting wholly of these instruments themselves. “Pension funds that invest in an impact fund would be investing indirectly in green bonds,” she says.

A recent explicit example of this is NN Investment Partners’ launch in March of its Patrimonial Balanced European Sustainable sub-fund, which includes green bonds. NN IP says adding the green bonds strategy allows investors to make a direct and measurable impact on the environment without any extra costs, since the bonds are priced similarly to non-green bonds and came from the same issuer.

Investing directly into a green bond fund, says Charles, would make a pension fund hostage to whoever else invests in the green bond market. “A pension fund would be far better deciding what its own values and objectives are and then finding a fund that does that,” she says.