The changing shape of the green bond market (part 2)

As the market matures, some investors are calling for more reassurance about the environmental benefits claimed for green bonds. Part two of this roundtable, organised by Environmental Finance with the support of DNV GL, explores the pros and cons of tougher standards and second-party opinions.

Graham Cooper: What are green bond investors looking for? Do they want a second party opinion or third party verification? Do they think there is a real need for standards in this market?

Yo Takatsuki: I think so, and in time definitely. The deals come and go quite quickly and we do not want to be spending a huge amount of time analysing them project by project.

I think there is a level of confidence that we need to receive from elsewhere, so a certain level of mandatory, independent verification, just to establish a baseline so that, every time a bond is labelled green, we can have confidence in it. So, in two years' time, our asset owners are not going to come back to us and say, 'What was that rubbish that you invested in?'

Lillian Georgopoulou: At the London Stock Exchange, we are trying to be as flexible as possible, so all we require from issuers is a third party certification, that is, a "second opinion" document that certifies the nature of the bonds. The choice of the certification provider is up to the issuer. We do not want to impose any further requirements, but we do set out minimum criteria that the third party certifier should meet, i.e. that they are independent, etc. That would suffice for us to move it into our dedicated green bond segment.

Yo Takatsuki: There is no doubt that SSA issuers (sovereigns, supranationals and agencies) have the most robust policies in place. Some have already got to the point where they are building a yield curve with benchmark sized issuances. That is not the case with corporates. For them, issuing green bonds may be akin to where CSR (corporate social responsibility) was 20 years ago.

Charles Smith: To help corporate issuers, we need flexibility. If you are going to say, 'We need a level of standard because that gives us clarity and it reduces the risk ...' to me, this standardisation and clarity may be good, but not if it comes at a cost of less diversity and growth of projects that are financed through green bond issuance.

Noelle Cazalis: I think that is where the market is stuck at the moment. Investors do not want to give up on pricing but also they require a certain standard of reporting, because we want to be able to assess the underlying projects. But then, from an issuer's perspective, it becomes more expensive because management needs to organise a roadshow to explain the different projects, and would then have to finance the annual reporting, the second opinion, etc. To grow, it feels like the market needs to compromise a bit, to find a balance between the investors and the issuers.

Charles Smith: And, when we start discussing standards, what are we looking at? Are we looking at the asset? Or are we looking at the issuer?

Emanuela Cernoia Russo: When we had our roadshow, we heard different opinions from different investors. So it would be interesting to understand more clearly what investors would like to standardise, so that issuers understand their expectations.

Pernille Holtedahl: I would have thought we had reached a certain agreement on standardisation by producing the Green Bond Principles. They are general principles and that is a good thing because they provide flexibility, yet some kind of robustness. They simply say, 'Think about reporting; specify what you are going to spend your money on; how do you select projects? etc.' They are fairly basic.

Noelle Cazalis: The key for us is transparency. So long as we have transparency from the issuer, then we can assess whether the issue fits our mandate.

Rhys Petheram: We will certainly support standards. If we really want to scale this market, we have to ensure credibility and standards are crucial for that, particularly as a lot of the growth is going to come from China and India.

Yo Takatsuki: I agree. I am not pushing for much tighter rules that could hinder the growth of the market. I think the Principles have played an important part in the development of the market but investors do have concerns about self labelling. You have no guarantees about what kind of reporting will come out on a regular basis and, unlike equities, with a green bond, we are generally buying it at issue, so the time in which we can do this analysis is significantly restricted.

Cathrine de Coninck Lopez: It is helpful to have the Green Bond Principles but we need more issuance so I would not want to stifle innovation by pushing too far towards unduly onerous standards.

Gavin Templeton: Until we have more consistency in measurement, I am not keen on imposing too many restrictions on issuers. And, to the point that was made about refinancing, a lot of institutional investors cannot invest in infrastructure but they can invest in bonds. So we think, 'Great, let us refinance this infrastructure and get these guys in there.' Because whether it is funds, or refinancing by the bond market, we need it all; the amount of capital required is absolutely massive.

Yo Takatsuki: Yes, green bonds can play multiple roles. We are increasingly presenting green bonds as a form of impact investment. For asset owners who are interested in these types of outcomes, we can say to them, 'Look, here is some reporting; there is an impact from the money that you are investing.'

Cathrine de Coninck-Lopez: And I would argue social bonds as well. In our UK Social Bond Fund, that is exactly what we do. We have a social outcome specific report to do exactly that. Now is it direct impact? I think the hardcore impact specialist would say 'no' because of the additionality point, but it is certainly moving in that direction. And you can sometimes have more targeted outcomes and impact in the bond market than in the equity market.

Charles Smith: Generally, I am very much in favour of transparency. And I think reporting is extremely important; a green bond issuer must know the environmental goal of their financing, and therefore they should be able to say something about both the purpose and expected impact.

But a word of caution about trying to reduce this to a simplistic number: there is currently no agreement on greenhouse gas accounting for energy efficiency. We have had cases in which we co invest in a project with other development institutions, and we come up with vastly different numbers. So it is extremely difficult to report on this without creating confusion.

Secondly, I find it worrying when I hear people just wanting to add things up and say, 'This is the total CO2 figure.' You lose a lot of context doing that. If I have one energy efficiency project in Kazakhstan and another in Germany, you are not even comparing apples and oranges; you are comparing apples and steak. They are probably very, very different.

For me, form follows function, so if we have a diverse, flexible, common sense type green bond market that needs to be reflected in the reporting.

Graham Cooper: What do you think is holding issuers back?

Cathrine de Coninck-Lopez: Well, from what I hear, a green bond rating costs about $30,000. It is pretty expensive and the process takes more time than for normal bonds.

Pernille Holtedahl: A number of issuers might be sitting on the fence and wondering, 'What is in it for me?' I think a lot of people are just weighing up the costs and benefits.

Doug Farquhar: Regarding the cost and the timescale of green bond issuance, that is where standards can help, in terms of scalability. I think that is the balance we have to get: to get standards that can speed up the issuance process and reduce the cost for an issuer, but without stifling the innovation in the market. And I think working through the Green Bond Principles is the right way to do that, as it is open and it is the same for everyone.

Emanuela Cernoia-Russo: We did our transaction in two or three weeks. And we were challenged a lot, internally, by our board to explain why we were doing a green bond, to explain the pros and cons. We are a public sector organisation; we use taxpayer money, so the decision to spend money on certification, etc., is not taken lightly.

I also have a comment on why there have not been more issuers in the sterling market. TFL, for example, tends to issue quite long term. The ten year bond we issued is short, for us. If we wanted to issue something longer in sterling, that would be quite welcome by many investors but having to report for 30 years would be quite challenging.

Justin Eeles: Presumably when a corporate issues a green bond to invest in a particular area, they are doing a certain amount of management accounting and reporting anyway. So the extra cost is formatting it to present to investors and presumably that is relatively low.

Pernille Holtedahl: It could be literally putting up a paragraph on the website.

Emanuela Cernoia-Russo: It is a low cost. But it is more than if you issue a normal corporate bond and it is more about making sure that you have all the systems set up for the next 30 or 40 years.

For us it is important to target different investors, which the green bond enabled us to do. The other thing is that, as a public sector entity, we also have a responsibility to support the mayor in achieving his environmental agenda. So the visibility of our activities was also important.

Mark Thompson: It is interesting that one of the reasons was diversifying your investors.

Charles Smith: For the EBRD as well, diversification of the investor base was a key reason. We specifically put together a small dark green bond programme dedicated to finding new investors. We are green as it is, but there are some investors who, for whatever reason, may feel they cannot invest in our generic bonds, and for whom our green bond programme is designed. This is why we do not issue billion dollar green benchmarks: because we do not target the same central banks and bank treasuries that usually invest in our bonds.

Part one of this roundtable can be read here.

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