50 Shades of Green: How Green are Green Bonds?
The World Bank defines Green Bonds as financial instruments which finance (or refinance) green projects and provide investors with regular or fixed income payments. Over 70 countries have pledged to reach net zero carbon emissions by 2050, an exercise which according to McKinsey will require close to $9.2 trillion to be spent each year to develop new green assets and decarbonise the global economy. With over $1.9 trillion raised through green bonds, they have often been hailed as being one of the most promising pathways towards reaching Goal 7 [Affordable and Clean Energy] of the United Nations' Sustainable Development Goals. Green bonds have seen significant triumphs and inter-alia have financed wind and solar farms to electrify rural households in Mexico, Peru, India and Jamaica and other developing nations. However, “green bond” issuers have contrastingly also used green bonds to raise millions of dollars for coal related projects in China and for major oil and natural gas companies in Spain and Thailand. There are numerous other such examples where issuers operate under the guise that these bonds will be used to improve efficiencies in these otherwise climate harming industries. This article seeks to highlight the urgent need for a universally accepted standardised definition on what constitutes a green bond to prevent the rampant “greenwashing” of bonds.
What's in a Name?
The root cause of the problem of greenwashing lies in the etymology of what bonds qualify to be a green. This is a problem which has existed right from the first green bonds that were issued. The World Bank claims credit for issuing the first green bond in November 2008 whereas the European Investment Bank states that its Climate Awareness Bond in 2007 was the world’s first green bond issuance. Herein lies the fundamental problem; Multiple prefixes such as “green”, “sustainable”, and “climate” used interchangeably with different (if any) regulation in multiple jurisdictions, enable issuers to classify activities which may not be strictly environmentally friendly or sustainable as green.
There are multiple incentives for issuers to greenwash their bonds. Chief among them is that green bonds are extremely attractive to blue-chip institutional investors such as pension funds and insurance companies (Entities which today command collective assets valued in excess of $100 trillion) who believe that in today’s low interest landscape, green bonds are a way to preserve wealth and provide reliable streams of revenue thus allowing issuers to quickly raise large sums of capital fairly easily. Additionally, and from a financial perspective perhaps most importantly, issuers are heavily incentivised to issue green bonds because of the premium (often referred to as “greenium”) that green bonds offer: the cheaper costs of financing or refinancing green bonds vis-à-vis comparable convention bonds. The greenium in many cases has been seen to be significant and the interest savings on offers for green bonds may be up to 25 basis points as compared to a conventional bond thus highlighting a massive incentive for issuers to greenwash their bonds.
The Current Regulatory Framework
As mentioned previously, the main reason issuers are able to greenwash their bonds is the ambiguity in the word green. This ambiguity does not stem from an absence of a coherent definition. In fact, there are numerous well-structured definitions on what constitute green bonds equipped with comprehensive oversight mechanisms to ensure precise end-use compliance until the green bond reaches maturity. The conundrum that arises however is that these definitions vary from one jurisdiction to another and they remain strictly voluntary. In my opinion, the regulatory framework laid down by the International Capital Market Association (“ICMA”) updated as recently as 2022 is the most comprehensive green bond definition, however the headnote of this definition itself mentions that it is voluntary, thus giving issuers the opportunity to flagrantly disregard the definition.
Coupled with this, there are jurisdictions with extremely vague definitions of projects which qualify as green. For example, in the People’s Republic of China, the world’s second largest and fastest growing green bond market, the definition of green projects also extends to projects which achieve pollution and greenhouse gas reduction. While on the face of it, this seems to a be a sensible classification, such broad definitions are the exact loopholes that mischievous issuers can exploit to greenwash their projects. For example, pollution reduction would include for “more efficient” fossil fuel burning projects within its ambit, the very antithesis of the global green and sustainability movement.
The Power of Investors
At their very core, all bond markets run solely on investors and investor sentiment. European investors have shown us that a collective conscience can minimize greenwashing within the EU by incentivizing issuers to value transparency. After the Repsol (the Spanish company referred to above) controversy of 2017, European ESG Investors made it very clear to European issuers that if their green bonds were to be successful within the EU, they would have to publicly signal their plans to initiate and accelerate sustainable business models. Interestingly, for some corporate issuers, strictly adhering to these transparency and reporting requirements has resulted in better pricing and lower market execution risk compared to what they would have been able to achieve in the traditional bond market. This is especially significant as there will be nothing more effective in driving down greenwashing than lower bond issuance costs. A Climate Bond Initiative (CBI) report on the green bond market in Europe in 2018 asserts that over 98% of green bond issuances in Europe has received at least one review from an independent institution such as Vigeo Eiris or International Climate Research (“CICERO”), guaranteeing the greenness of the bond.
The Road Ahead
The interesting thing about the problem of greenwashing is that it is a well-identified problem and the tools to resolve it are all well within the reach of all stakeholders. The European Union, while still not perfect, has paved the way to show us how greenwashing can be systemically eradicated with economic benefits to all stakeholders and the rest of the world can take heed. A continuous global dialogue to unify the definition of “green” can also go a long way in the global alignment of the understanding of what bonds qualify. This is a method with demonstrated results; after a lot of international criticism and dialogue, the People’s Republic of China agreed to remove controversial coal investments such as “clean” coal use from its green bond dialogue, bringing China into closer alignment with international standards. Governments around the world can explore building in standard definitions and end-use monitoring mechanisms of green bonds into existing multilateral climate treaties like the Paris Agreement. Over and above, governments can consider giving green bonds which truly subscribe to these internationally agreed definitions, tax benefits. This will go a long way in both ensuring and incentivising both green issuers and investors to truly remain green. In a rapidly changing world, where the only thing that is certain is climate change, green bonds need to truly go Green to make the globe go green.
Sanjit Ganguli is a Corporation LL.M. candidate at NYU and serves as a Graduate Editor of the NYU Journal of Law & Business. Prior to attending NYU, Sanjit worked for four years as an in-house counsel with ICICI Bank, a systemically important financial institution, at their offices in India and Singapore. At ICICI, his practice largely focused on project finance (both domestic and overseas) and cross-border structured finance as well as debt capital markets.