BREAKOUT C: Green Bonds
Rapporteur: Kris Holz
The YSIF Green Bonds breakout opened with one of the guest speakers, a lecturer and research associate focused on climate finance, presenting a recent paper on the evolution of green bonds and the challenge of risk commodification. Specifically, the paper explores the difficulties in quantifying the “green risks” of a bond and the current market methods for doing so. The bearers of green risks are largely concerned with reputational rather than economic risk – if a green bond does not perform as advertised the issuer is not at risk of entering into “green default”. However, depending on the nature of the investor, reputational risk associated with a failed green bond can carry varying levels of weight. This results in varying investor expectationsfor rigor with respect to the quality of green risk evaluation. Consequently, the issuers and evaluators of green bonds are caught between the needs of portfolio managers who would prefer to see a measure of risk evaluation simple enough to fit within typical risk indices and the interests of entities such as governments and nonprofits whose criteria for green performance may necessitate deep evaluation of green impacts. The introduction of green verification providers to the green bonds landscape has helped move the markets towards standardization of green metrics, but consensus among green bonds’ diverse set of stakeholders is still insufficient enough to constrain liquidity.
Following the presentation, the first speaker was joined by a practitioner of green infrastructure and equities investing, as well as a moderator who directs responsible investment for a large financial services organization. The moderated discussion began by diving further into some the environmental risks both speakers have seen recently in the market as well as concerns around the breadth of “greenness”. One of the key difficulties the speakers experience in quantifying green bond risks is capturing the risks of failing to achieve the desired environmental impact. While issuers typically succeed in using green bond proceeds as intended, and the risks around project development are typically well-known (e.g. solar project construction risk), the ability to quantify likelihood of environmental outcomes is often still beyond our grasp. Especially for more complex projects, like climate adaptation, the outcomes are broad and difficult to measure for distillation into a bond rating. Even for relatively straight-forward uses of proceeds such as solar development, the broader universe of environmental and social benefits – impact on grid stability, electricity prices, particulate air pollution, etc. – are typically not captured. When green bonds are issued with the explicit intent of facilitating a broad range of social benefits in addition to more traditional green outcomes, issuers must provide a detailed plan for achieving their goals to avoid the reputational risk associated with a mismatch between investor expectations and project outcomes. To date, public sector issuers have shown particular strength in providing this increased level of transparency and reporting.
Upon opening the floor to audience discussion, the conversation quickly became focused on the underlying drivers of variance in green bond verification standards. While there is clearly a discrepancy in reporting needs between various investors, the audience identified a core philosophical barrier in whether green bonds standards should be developed with the intent of being a comprehensive and strict set of metrics that can be applied broadly, or whether a green bonds standard should just be more of a loose set of guiding principles more intent on financing universally accepted green goals that meet a minimum outcome. The consensus among the audience (mostly investment practitioners, with a few academics) was that there is not enough convergence on green goals to simply focus on broad outcomes. Since there is a wide range of desired environmental outcomes, setting a minimum threshold will be difficult and introduce further heterogeneity into green bond labels. Instead, adopting a comprehensive set of metrics will allow for standardization, further reputational risk mitigation, and less transaction cost once verification becomes commoditized.
Turning towards metrics, the audience then discussed how such metrics should be developed and how recent events reflect the need for participation from all stakeholders – issuers, underwriters, and investors – in identifying key metrics. For instance, the Spanish oil and gas exploration company Repsol issued a green bond in May that was verified by Vigeo Eiris, yet not included in a variety of green bond indices due to Repsol’s focus on oil and gas. While the use of proceeds was expected to remove 1.9M tons of annual GHG emissions, there was for rigor with respect to the quality of green risk evaluation. Consequently, the issuers and evaluators of green bonds are caught between the needs of portfolio managers who would prefer to see a measure of risk evaluation simple enough to fit within typical risk indices and the interests of entities such as governments and nonprofits whose criteria for green performance may necessitate deep evaluation of green impacts. The introduction of green verification providers to the green bonds landscape has helped move the markets towards standardization of green metrics, but consensus among green bonds’ diverse set of stakeholders is still insufficient enough to constrain liquidity.