Green bonds are starting to come in many different shades as the size of the market for securities designed to benefit the environment is on track to double again.
Those are two of the conclusions that emerged from the industry’s biggest annual gathering this week in London. Issuance may surge to $206 billion this year from $93 billion in 2016, according to Moody’s Corp.
As more bonds are issued by a wider variety of institution, investors are starting to track exactly how green those securities really are. So-called dark green bonds adhere to the strictest environmental criteria, while ones described as having a lighter shade can be used to back a broader array of projects. Financial innovation in creating new types of green bond will keep demand growing, said Michael Sheren, an adviser to the Bank of England.
“There’s about $100 trillion of institutional money in the world, and less than 1 percent is invested in anything green,” said Sheren, who is co-chair of the Group of 20’s Green Finance Study Group. “We have to make it palatable to institutional investors. Green bonds are the best instrument to do this.”
Following are other trends that emerged at the conference hosted by Climate Bonds Initiative, one of the organizations that establishes guidelines for the unregulated green-bond market:
Green Securities Will Come in More Varieties
The first covered and mortgage-backed bonds emerged last year with differing levels of greenness. This year, prices for green securities may start to command a premium to regular bonds — if metrics can justify it.
“We need to go beyond the green labeled bond market to turn the world’s infrastructure green,” said Michael Wilkins, managing director of S&P’s infrastructure ratings. “This would look at environmental impact, net benefit as well as resilience and adaptation.”
S&P Global Inc. is working on an evaluation tool with a scoring system that would go beyond labeling a bond green and not-green. It will quantify a green bond’s transparency, governance and contribution to mitigation or adaptation to climate change. S&P is planning to introduce it in the first quarter.
Two green bond exchange-traded funds have debuted. The first was by Lynxor on March 2 and is listed in Luxembourg. The second was introduced four days later by VanEck Vectors. It trades on the New York Stock Exchange.
Green bonds may be linked to equities or other structures this year, said Natixis SA. The French investment bank has created green bonds that pay out at maturity depending on the performance of an equity index instead of issuing a periodic coupon like traditional bonds do. It’s also working on green fixed-income instruments with a synthetic coupon, a structure that mimics the cash flow of a bond.
“It requires the investors to hold the bond until maturity,” said Orith Azoulay, head of SRI research at Natixis. “We’re seeing interest from bond investors trying to get some kind of yield pickup.”
Another Record Will Fall
Moody’s Vice President Henry Shilling said the green bond market grew 120 percent last year and will more than double again. His prediction is more punchy than the estimate from Bloomberg New Energy Finance that the green bond market will grow to $123 billion this year from $95 billion in 2016.
“Our 2017 forecast is a little less aggressive,” said Dan Shurey, analyst at BNEF. “2016 was an unusually large year for green bond activity. China was playing catch-up to Western markets. We expect 2017 to return to slightly lower levels of growth, around 30 percent.”
Shilling expects the Paris agreement and China’s growing appetite for everything clean and green to keep the market’s momentum strong.
A Sovereign Green Giant Will Awaken
Poland issued the world’s first sovereign green bond in December. France followed with a 7 billion-euro ($7.4 billion) issue in January. Nigeria’s planning to sell domestic naira-denominated climate debt this month. Those countries are in the vanguard of a sovereign green bond movement that expected to be joined this year by at least nine other governments.
“We’ll be seeing sovereign issuance in emerging markets,” said Philip Brown, head of sovereign, supranational and agency debt capital markets at Citigroup Inc. “Everyone is thinking about doing one of these things. Pretty much every finance minister is fully up to speed.”
China Will Lead on Issuance
China’s $36 billion of green bonds issued last year made up about a third of the market and the world’s most populous nation may again double issuance in 2017, according to Tracy Cai, the Chief Executive Officer of Beijing-based Syntao Green Finance, a consultancy that works with financial institutions to develop sustainable investments.
“Green bonds made up 2 percent of China’s bond market last year,” Cai said. “In order to reach targets set by the government in Beijing, issuance would have to rise to 20 percent.”
The People’s Bank of China estimates that 2 trillion yuan to 4 trillion yuan ($289 billion to $579 billion) must be invested every year in order to fix environmental problems and mitigate climate change. Public money will cover only 15 percent of its needs. China needs private capital to pay for the rest.
The government is also exploring tax incentives on green bonds and may cover the interest paid on the debt with a tax credit. The People’s Bank of China proposed an incentive for labeled green bonds in China last April that could reduce funding costs by 100 basis points, or 1 percent.
Green Bonds Will Sprout in Brazil
The Brazilian Development Bank, known as BNDES, recently announced a 500-million real ($159 million) sustainable energy fund and is seeking to tap the green bond market to expand the fund in the second half of 2017.
Six major Brazilian investors including BTG Pactual Group, Itau Global Asset Management Ltd. and UBS Brasil Banco de Investimento SA signed a statement last November to back the development of a local green bonds market.
“Brazil has a great need to increase sources of funding,” said Guilherme Stodart, manager of the bank’s London office.