Just how green are ‘green’ bonds? Issuers come under scrutiny as supply and demand mushroom


The green bond market is teeming with new investors, and issuers are expanding supply on all fronts – issuing ever-riskier types of debt under a green label, and causing some observers to ask whether the market is growing in the right direction.

In July, Spanish bank BBVA drew attention from analysts by issuing a EUR1 billion green hybrid bond which qualifies as additional Tier 1. Rather than going to fund environmental projects, the bond’s proceeds could instead be used to absorb losses on the bank’s other assets if there were a financial downturn. 

“It is quite clear that the use of the proceeds raised from that bond could be used to repay another bond,” says Monsur Hussain from Fitch Ratings.

Hussain says this issuance was “pretty unusual” and that there are likely to be no more than around five of such bonds issued today by financial institutions.

“Most of the big issuance so far has been on the senior side, and now we're seeing this trickle down into subordinated instruments, which are popular with the investor base because of the potential for better pricing and yield pick-up,” explains Hussain.

But this is not the first instance of subordinated debt being issued as a green bond. Johann Ple, who manages two green fixed income funds for AXA Investment Managers, notes that Italian insurance giant Generali also issued subordinated debt as green bonds in June 2020 and September 2019. 

“Now, BBVA is going even further and putting the most subordinated tranche that you can have into a green bond. I think it's a positive move because it provides a lot more diversification in terms of how you want to allocate risk in this universe, especially if you focus exclusively in this universe.” 

BBVA’s recent additional Tier 1 green bond was offered with a 6 per cent coupon.

“In the very low yield environment which we are in, we always welcome additional sources of value or yield,” says Ple, adding that “this is the kind of structure that we encourage other issuers to come with”.

He argues that the addition of instruments lower down in the capital structure allows investors with different risk appetites to enter the market. 

“There is a strong dynamic of growth in the green bond market, and this growth is providing a lot of diversification in terms of sectors, issuers, and in terms of seniority of issuance. This is enabling the green bond market to converge in terms of characteristics, and also risk/return profile, with the conventional bond market,” says Ple.

The volume of green bonds issued this year has already exceeded USD100 billion, and seems likely to continue to surge as the year goes on. Germany, Spain, Italy and Sweden have all announced their intentions to join the pool of sovereign issuers of green bonds in the coming months. 

Supply is surging in line with rising demand from institutional investors, more of whom are being mandated to invest in sustainable assets. According to a survey by BNY Mellon and OMFIF, 76 per cent of global public investors ranked green bonds as their preferred asset class out of all sustainable investments, and 45 per cent said they planned to grow their allocations to green bonds over the next two years.

Fitch says the lack of clarity over where the BBVA bond proceeds will be used matches the general status-quo in green bonds. 

Issuers “may choose to put that funding towards sustainable investments or ecological lending, but this is by no means a constraint”, says Hussain. “Very, very few green bond issuances to-date, whether senior or subordinated, have the use of proceeds linked to the bond through covenants.” 

Despite the surge in issuance and demand, Hussain calls the regulatory environment surrounding green bonds “embryonic at best”. 

If regulators were to get more involved, this would likely mean the ring-fencing of green assets and liabilities. Hussein warns that this would also “weaken banks' capital resilience because ring-fencing limits the ability of stronger parts of a banking group to support weaker parts”.

The Climate Bonds Initiative (CBI) is an organisation that is pioneering voluntary standards for green bonds, with its own methodology for certifying green bonds. Its co-founder Sean Kidney has also assisted in creating the upcoming EU taxonomy. 

Almost eight per cent of green bonds issued in 2020, worth USD8.8 billion, did not meet CBI standards for being labelled ‘green’. Three quarters of those ‘green’ bonds failed to meet CBI standards because their use of proceeds did not qualify as green. 

Past examples include large Chinese issuance that went to fund ‘clean coal’ projects, although Chinese regulators since announced in June they would begin excluding fossil fuels from their green bonds taxonomy. 

According to Alan Meng, deputy head of Global Data Services at the CBI, the use of green bond proceeds is the “most important” factor in deciding whether an issuance is ‘green’. 

Bonds also failed to meet CBI standards when issuers allocated less than 95 per cent of proceeds to qualifying green projects, and when the issuers did not disclose enough information for CBI to make a judgment. Since the CBI uses information published by issuers, if issuers fail to give accurate accounts at the time of issuance, their ‘green’ status is only challenged much later in CBI’s post-issuance reports.

The CBI also runs a certification scheme for issuers that want to back up the green credentials of their bonds, where the assets and projects that are needed to deliver a low carbon economy are identified, and then assesses the expected impact of investing in those projects.

Meng gives the example of a municipality issuing a bond to fund an upgrade its metro lines, which would reduce carbon emissions: “We require a minimum threshold on the carbon emissions reduced by the project on the metro line, which are required on per passenger, per kilometre basis. They have to justify the expected impact of the project can meet that minimum threshold.”

But these standards, as well as those developed by the EU, are all voluntary. Hussain notes that issuers can “shirk those guidelines, and still label their issuance green or sustainable”. 

The only risk banks currently face if they do not use proceeds from a green bond for suitably green investments is that of “reputational damage”, says another analyst at Fitch Ratings, Janine Dow. 

“Most of the documentation for these products tends to have some elasticity for the use of proceeds. You could argue this is perfectly reasonable, just in case there is a hiatus in a particular lending programme to ensure that the funding can be put to alternate use. On the other hand, it can be seen as disingenuous from an investor perspective,” adds Hussain.

On the other hand, issuers also take the risk of not reaching the full pool of potential investors if they do not start improving transparency and accountability.

Existing green bond investors such as AXA’s Ple already caution against investing in green bonds “just because they have been self-labelled by issuers”. 

“There should be efforts made to ensure purchases are concentrated on financing projects that have clear environmental benefits, and which come from issuers that have a credible sustainable strategy,” says Ple. 

AXA says all the green bonds it invests in are in line with the ICMA Green Bond Principles (GBP), an alternative set of standards for green bonds, as well as an in-house framework it uses to screen potential investments.

Not all investors have been convinced, though. Tabula Investment Management is one firm that does not currently offer investments in green bonds. Its CEO, MJ Lytle, who previously spent 18 years at Morgan Stanley working on bond issues, says this is because the amount of work that investment firms have to do to establish a bond’s real green credentials before investing is “disproportionate”.

The green bonds market lacks accountability, but Lytle says there is a chicken and egg problem when it comes to who ought to be calling for higher standards. “Right now, the issuer wants to issue a green bond because they reckon they could raise more money with a tighter spread. The investors want to tick boxes with things like green bonds, that they can then put into portfolios they otherwise couldn’t.”

Lytle believes that accountability should not be seen as a burden on the issuers: “Anybody out there who says ‘That’s not fair’  is taking the classic Neanderthal financial approach that says, ‘We live in a capitalist society, if you put too many constraints on us, nothing will work properly’. The whole reason we have constraints is in order to get things to work better than they do in a Hobbesian free-for-all.”

He notes that when ESG equity investments were being pioneered twenty years ago, investors made assertions about the ESG credentials of their stocks, but had very little real data to support it. Firms like Sustainalytics and ISS then started to gather data on these companies and published guidelines for firms reporting non-financial information, and eventually “corporates felt the pressure to actually do the work themselves”.

A similar process has to happen in the green bonds market before it becomes a fully credible market: “Somebody has got to insert themselves and try to figure out a business model for getting paid to do this work,” says Lytle.

Until that point is reached, the question mark over a bond issuer's green credentials will be enough to put some would-be investors off.