Green bonds, while often associated with environmental protection, are not always as eco-friendly as they seem.
Green bonds, a growing financial instrument, are being issued in response to environmental laws, growing environmental awareness, and increasing investor pressure. These bonds are designed to fund projects that have a positive environmental impact, but it's essential to scrutinize their credibility and additional benefit to ensure they deliver on their promises.
Core Factors for Credibility and Impact
When evaluating a green bond, several key factors come into play. First and foremost, the use of proceeds transparency is crucial. The bond issuer should clearly define and disclose the eligible green project categories funded by the bond proceeds, specifying whether financing is for new projects or refinancing existing ones.
Another critical aspect is the project evaluation and selection process. A rigorous assessment method is necessary to ensure only projects with verifiable positive environmental outcomes receive financing, thereby preventing "greenwashing" – claims that projects are green without substantive impact.
Management of proceeds is another essential factor. Proceeds should be ring-fenced and managed separately, so they are exclusively allocated to projects with environmental benefits, with transparent tracking systems for use of funds.
Regular reporting with quantitative impact indicators, such as greenhouse gas emissions avoided, energy saved, water conserved, waste diverted or reduced, using internationally recognized standards, boosts credibility. Transparent, measurable, and material impact metrics are essential to verify environmental benefits.
External verification enhances trust in the bond's green credentials. Independent assurance or verification of the bond's compliance with frameworks such as the International Capital Markets Association (ICMA) Green Bond Principles is highly beneficial.
Adherence to established frameworks, such as the ICMA Green Bond Principles, is a hallmark of credible green bonds. These guidelines emphasize four pillars – use of proceeds, project evaluation and selection, management of proceeds, and reporting.
Avoiding overly ambiguous criteria is also important. Claims based on expected environmental certifications, such as LEED certification in progress but not yet achieved, are less credible unless clearly backed by measurable conditions.
Assessing Additional Environmental Impact
To determine a green bond's additional environmental impact, it's crucial to consider whether the projects generate additional environmental benefits beyond a business-as-usual scenario. Clear distinction and estimates of financing vs. refinancing help assess this.
The Importance of Analysis
The significant growth of the Green Bond market underscores the importance of analysing individual emissions precisely to avoid low additional value Green Bonds. A case-by-case analysis of the credibility and additional benefit of individual green bonds is necessary for security selection.
In 2021, it is expected that $500 billion worth of green bonds will be issued, nearly half of the total investment since 2007. However, not all green bonds achieve their stated goals, and not all issuers have processes in place to monitor and disclose the impacts achieved.
The Role of ESG Impact Ratings
ESG Impact Ratings provide analysts and portfolio managers with a holistic view and a forward-looking perspective on the long-term sustainability of a issuer's business. These ratings can help investors make informed decisions about which green bonds to invest in.
Green Bonds in the European Union
The European Union will issue green bonds worth €225 billion as part of its COVID-19 recovery package. These bonds will be subject to the same scrutiny and evaluation as other green bonds to ensure they deliver on their environmental promises.
Third-party statements and certifications, such as the Climate Bonds Standard and the EU Green Bond Standard, can support the analysis of a green bond's credibility, but are not mentioned in this article.
In conclusion, assessing a green bond's credibility requires examining transparent use of proceeds, rigorous project selection, independent verification, measurable impact reporting, and adherence to recognized frameworks, while additional environmental impact depends on whether projects provide genuine, measurable benefits beyond normal investment activities.
When making investment decisions about green bonds, it is critical to evaluate their credibility by considering transparent use of proceeds, rigorous project selection, independent verification, measurable impact reporting, and adherence to recognized frameworks such as the ICMA Green Bond Principles. To determine a green bond's additional environmental impact, it's essential to assess whether the projects funded generate additional environmental benefits beyond a business-as-usual scenario, as the European Union will subject its €225 billion worth of green bonds to these evaluations for their COVID-19 recovery package.
