The Financial Times has an article today of interest to issuers and buyers of Green Bonds. Apparently, Green Bond funds, of which there are an increasing number, are having difficulty finding Green Bonds to buy because not enough bonds meet their criteria. This is an interesting and probably unexpected problem for the Green Bond market to have–not enough Green Bonds to meet fund demand. It’s a criteria issue, certainly–to sell the Green Bond concept to investors, fund managers need to be pretty clear about what they will invest in. And many of these criteria, not unlike the Green Bond Principles, sometimes appear a bit remote from what is actually going on in the bond market. People buy Green Bonds for all sorts of reasons, not just the fact they’re Green. An investor just might happen to need a seven year European utility that day. It’s hard to tell, frankly. (Syndicate desks and Capital Market groups probably know, but they’re not telling.) But it’s also hard to believe that a benchmark size Green Bond issue from a European utility is being driven solely by the Green Bond investment community.
The problem, if that’s what it is, is that the Green Bond market itself has been rather casual about the criteria issue–there are any number of Green Bond issues where the criteria are undefined, or pretty weak, and the market doesn’t seem to care deeply. When Iberdrola issues a Green Bond to refinance the acquisition of windfarms, or when Toyota issues a Green ABS issue backed by hybrid car loans, is the market going to object if there is no targeted criteria or third party verification? Of course not. This has actually been a positive characteristic of the Green Bond market, one that we believe has allowed it to grow relatively unconstrained by the issue of “Green-ness.” Yes, there is a issue of criteria, as the recent Repsol issue indicated–there are limits, as it turns out, to what the market will accept as Green in a self-labelled Green Bond market. This is a good thing–the market can tell the difference between a Green Bond being used to finance expansion into renewable energy and a “Green Bond” that simply allows Repsol to get fossil fuels out of the ground more efficiently. Good–this is exactly the kind of difference you want the market to be sophisticated enough to be making. On the other hand, we believe that the relative looseness of the criteria issue has hardly been a deterrent to issuance overall.
Unmentioned in the article is, we suspect, a different reason entirely for the problem Green Bond managers may be facing. Green Bond issuance has been so broad across bond sectors–corporate, municipal, sovereign, supranational, ABS, even pfandbrief–that casual observers may not have noticed that the growth in the corporate market has actually been relatively slow as compared with other sectors over the past two years or so. And, of course, there’s a limit to how much managers can co-mingle funds across bond sectors–particularly US municipal bonds, which have accounted or a significant percentage of Green Bond issuance the past several years, and which have different tax implications for bond buyers. In addition, the last we checked, the corporate Green Bond market was still largely dominated by three sectors–energy and utilities, property, and financial institutions. This suggests that the difficulty Green Bond funds is facing may be less finding enough Green Bonds to buy than finding enough diversification in the Green Bond market for portfolio construction–especially in a market where issuance continues to be dominated by triple-A supra-nationals and, increasingly, US municipal bonds and Chinese bank domestic issues.
So it’s probably not the case that Green Bond fund criteria are too stringent. In the end, it will be investors who determine that anyway–funds with criteria that don’t satisfy what investors want from such products will simply go away. What the Green Bond market needs is more corporate diversification. What has been mildly disappointing about Green Bond market growth, to us anyway, has been the relatively slow pick-up of Green Bond issuance in, say, the consumer/retail or manufacturing sectors relative to, say, the energy and power sectors. Until investment banks and potential issuers are able to address this imbalance, we suspect the problems faced by Green Bond fund managers will continue to provide fodder for articles such as this one.