Time to consider green bonds?

Key points:

• Green bond issuance in 2019 was up 51% on 2018 levels
• European Commission and European Central Bank among authorities committing more to sustainability finance
• Governments around the world likely to turn on spending taps and target climate-change initiatives 
• Green bond yields or spread premium are similar to, and in some cases lower than, their conventional peers.

Climate change initiatives look set to profit from one of this year’s likely key investment themes; increased government spending as central banks move closer to having little, if any, monetary ammunition left with which to support economies.

As the authorities take more action to address climate change concerns, any increase in fiscal spending may include funds directed in this direction. For instance, the European Central Bank and the European Commission have made large commitments to sustainable finance. Similarly, with their increased emphasis on sustainability of investment strategies, investors such as family offices, sovereign wealth funds and mutual funds are likely to seek more sustainable assets, including green bonds.

Green bonds have seen a sharp rise in popularity. Issuance rose by 51% in 2019, on 2018 levels, to reach $260bn. As much as 45% of issuance came from Europe, followed by Asia and North America. More recently, the Middle East and Latin America have joined the bandwagon after Saudi Arabia’s Islamic Development Bank and Chile successfully launched such bonds.

A green bond can be defined as one where the proceeds will be exclusively applied to eligible environmental and/or social projects. For instance, the International Capital Market Association suggests that at least 95% of the bond’s proceeds must be earmarked for such projects, which is often tracked and reported by issuers.

Are there greater returns from green bonds?

Despite the apparent sustainability attractions of green bonds, it can be difficult to measure how much environmental or social impact that they make. Differing definitions and impact variations from issuers cloud the issue and it is to be hoped that more transparency emerges in time.

For all the sustainability credentials of the asset class, can green bonds produce investment returns that are at least as good as those from conventional ones? There is no evidence of superior returns yet, though it is early days. The European Development Bank issued the first green/climate bond in 2007.

That said, yields or spread premium are similar to, and in some cases lower than, their conventional peers. The marginally lower yield of green bonds may result from the extra demand from dedicated responsible mandates and limited choice of bonds.

The credit quality of green bonds relative to conventional ones is the same. However, businesses that issue green bonds often place much emphasis on governance and sustainability when defining company strategy. This approach is likely to mean that any debt is more resilient and less exposed to negative scenarios over time.

In addition to green bonds, more investor attention is turning to bonds linked to the quality of environmental, social or governance (ESG) practices of the corporation, sometimes known as sustainability bonds. This seems like an attractive proposition for investors wanting to consider the overall ESG performance of an issuer rather than just one element of the company’s activities. No matter which format wins, investors, issuers and governments are embracing the initiative.

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