Green bonds have relatively simple structures and credit quality and yield levels similar to AAA bonds, meriting “consideration as an allocation within a fixed interest portfolio,” but a lack of issuance depth is a challenge for institutional investors, according to investment consultants Mercer.
A recent Mercer report comments on rates green bonds’ structure and risk/return characteristics, as well as citing the belief by green bond issuers that there is a correlation between financial sustainability and environmental, social and governance factors. The Climate Bonds Initiative and the HSBC Climate Change Centre of Excellence found that there is USD$174bn worth of climate-themed bonds outstanding today, covering sectors including energy, building and industry, climate finance, water, waste and pollution controls, agriculture and forestry.
Green bonds are tied to financing projects that benefit the environment, mitigate climate change or adapt to the impacts of climate change. They combine that explicit environmental mission with a similar profile to standard debt instruments, covering treasury-style bonds, treasury-style retail offerings “involving a coupon linked to carbon credits or green indexes” and asset-backed securities tied to “green” infrastructure projects or portfolios of projects, according to Mercer. Many of the bonds are issued by supranational institutions such as the World Bank, the Asian Development Bank and the European Investment Bank.
Green bonds could be considered by investors that integrate ESG into their investment portfolios, but one large barrier for institutional investors is the lack of issuance scale.
“The biggest issue I suppose for green bonds is that there needs to be much more traction and momentum,” said Helga Birgden, Mercer’s head of responsible investment in Asia Pacific. “The supranationals are pushing them, but governments need to push them as well. There also needs to be a lot more education among institutional investors and pushing on the issuance side.”
The lack of issuance and liquidity are two issues, and a third is a set of standards. The Climate Bonds Initiative has launched a set of standards for verifying green bonds’ credentials, Mercer notes. Despite the lack of depth in the market, Mercer does evaluate green bonds as well as few fixed income managers on their integration of ESG into their investment processes, Birdgen said.
“There are robust processes and Mercer has rated a very limited universe of green bonds, highly,” she said. “There are ways of measuring the process and while there aren’t many what we’d call ESG I and II [the highest ratings under Mercer’s ESG rating system] fixed income managers integrating in that way, there are some. There are managers capable of doing it in a robust way. That’s not the issue – the issue is on the depth of the market and the need for greater issuance.”