The growth of the green bond market has been significant. Over US$700 billion in green bonds has been issued since the World Bank issued the first green bond in 2008. Issuance has more than quadrupled in the past five years, climbing above US$200 billion for the first time by November 2019, according to the Climate Bonds Initiative (CBI) and surpassing the record US$173 billion total issuance recorded in 2018.
Green bonds include a commitment to invest in sustainability-oriented projects, based on the Green Bond Principles (GBP) as set out by International Capital Markets Association (ICMA). These cover "any type of bond instrument where the proceeds will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible Green Projects that are aligned with the four core components of the GBP":
- Use of proceeds—an amount equal to the bond’s proceeds must be allocated to “eligible projects” which include renewable energy, energy efficiency, pollution prevention and control, eco-efficient and/or circular economy adapted products, production technologies and processes, green buildings, terrestrial and aquatic biodiversity conservation, and clean transportation.
- Process for project evaluation and selection—a framework that aligns with the GBP and is certified by a second party opinion provider, such as Vigeo Eiris or Sustainalytics.
- Management of proceeds/proceeds reporting—annual disclosure on the amount of proceeds disbursed over time, sometimes with an attestation by the issuer’s auditor.
- Reporting—ongoing sustainability reporting, typically annually.
Major global players are now making their presence felt in the green bond arena to fund their sustainability agendas and build their green credentials.
For example, in October 2019, PepsiCo issued its inaugural US$1 billion green bond, which will be used to finance a reduction in its use of virgin plastic, reduce its greenhouse gas emissions and improve its water-use efficiency. In doing so, PepsiCo was able to achieve its lowest-ever 30-year coupon rate at 2.875%.
Another example is Apple, which issued an aggregate of US$2.5 billion in green bonds in 2016 and 2017, making it one of the largest corporate issuers of dollar-denominated green bonds. The first bond was dedicated to financing environmental projects, including renewable energy initiatives across Apple’s global facilities. The second was allocated to a total of 28 eligible projects tied to three environmental priorities where the company believes it can make the greatest impact, including renewable energy sources, energy efficiency and safer materials in products and processes.
Apple also issued its first euro-denominated green bonds in November 2019, raising €2 billion (US$2.2 billion), with the proceeds allocated along the same lines as the earlier bonds.
Banking boosts values but energy is prime mover
While the green bonds issued by these two consumer behemoths are significant, sectors from government agencies to sovereigns, real estate, automotive, forest and paper, shipping, airlines, cement, metals, mining, oil & gas and chemicals, are also represented.
The banking sector currently accounts for the highest green bond values globally, with US$49.2 billion issued in 2018 according to CBI data, or 28% of the annual global total for that year.
This trend looks set to continue: According to a report published in May 2019 by the Boston University Institute for Sustainable Energy (Assessing the Potential for US Utility Green Bonds), the US utility industry has the capacity to issue at least US$250 to US$500 billion of green bonds.
Why green bonds? Why now?
Public opinion on climate change is shifting, swayed by a visible rise in natural catastrophes and extreme weather events coupled with growing activism on a global scale. Consumer preferences are shifting in support of sustainability, as exhibited by the recent success of plant-based meat substitutes. Energy from renewables is becoming a popular, proven, reliable source of power rather than a disruptor. Consumers and investors alike are calling on the business community to act now.
Corporations understand that sustainability has implications for corporate finance, capital allocation, and therefore valuation. Investors are increasingly focused on environmental, social and governance (ESG) factors as criteria for investing, and there has been notable growth in ESG investing. Government policy is adding regulatory pressure, requiring companies to improve their ESG reporting. Corporations, in turn, are responding to their stakeholders—who include customers and investors, but also employees and potential applicants—and regulations by publishing sustainability metrics and making public statements regarding their commitment to reduce emissions.
Issuing green bonds highlights a company’s environmental conscience, a positive signal to both capital markets and buying consumers. Other benefits include access to capital, risk management, brand value and reputation, human capital and employee retention and recruitment, ability to acquire other high-quality companies and the company’s value as an acquisition target.
All of this points to a bright future for the market.
Room to grow in the US and Latin America
Europe has led the charge in green bond issuance, in keeping with a coordinated policy to cut carbon emissions and establish other environmental protections—the EU Commission has already begun implementing its Sustainable Finance Action Plan and is consulting on a legislative proposal to establish an EU Climate Law framework for sustainable investment.
According to the CBI, European issuers observed the third-largest year-on-year regional growth rate of 15% by the end of 2018, maintaining Europe's spot as the largest green bond market overall, with US$190 billion of issuance since 2007 or 37% of the US$520 billion total over that period.
North America, has made slower progress than Europe despite being the second-largest regional market cumulatively (US$137 billion to date). This is consistent with the US government’s retreat on environmental sustainability commitments and policies in recent years.
Nevertheless, some of the country’s most visible corporates have been leading the charge and, as mentioned, the US utility sector holds massive potential in the financing of its future renewables projects. Further, despite intransigence on the part of the current US administration, state-level progress is being made, particularly in California. State Treasurer Fiona Ma has said the intention is for California be a model not only for other states, but also for countries.
APAC meanwhile has rapidly gained ground as the third-largest regional green bond issuer (US$120 billion), owing to China's entry into the market as recently as 2016. APAC also superseded North America for annual issuance for the first time in 2018. It accounts for over 70% of total emerging markets issuance to date and is expected to continue its strong policy engagement.
However, some assets that are included in the China Green Bond guidelines are not compatible with the CBI Green Bond taxonomy so are currently ineligible, and therefore excluded from the CBI database. These incongruences show signs of diminishing as green bond issuance increases and international harmonization initiatives grow.
Latin America is the fourth-largest cumulative market but is a long way behind APAC, with US$7 billion issued to date. Brazil accounts for around half of this volume and, while the country's political and economic issues may have kept some investors at bay, there is reason to believe the market will grow significantly over the next five years. The continent is seeing interest in financing its huge infrastructure demands.
In 2019, Chile issued Latin America’s inaugural sovereign green bond, the use of proceeds being earmarked for infrastructure initiatives, including electrified public transport, renewable energy and sustainable building projects.
While some have questioned the green bond market’s ability to sustain its expansion, for now it is enjoying spectacular growth that shows no signs of slowing. Government sustainability commitments and rising consumer awareness of the impact businesses have on the environment mean the genie is out of the bottle.