The appetite from issuers and investors for green finance continues to strengthen worldwide: globally, issuance of labeled green bonds (PDF) jumped to nearly $160 billion in 2017. And while the United States trails China, France and Germany, labeled green bonds issues there, too, are growing — and the self-labeled U.S. green bond market more than doubled in 2017, powered by a mix of municipalities, states and large corporations.
But as new types of issuers enter the market and more innovative green financing instruments are created, the evolution of mandatory standards is essential to ensure that investors can identify and evaluate risk.
Investors seeking to build up their green portfolios will need assurances of best practice and reliable ways to monitor the quality of green instruments — regardless of which geographies or industries they invest in.
For issuers, common standards can help clarify options in terms of issuance — and ensure they are both structuring the deal appropriately and reaching the right investors for their project.
Standardization also can help enable innovation by establishing a level playing field. ING was first to issue a sustainability rating-linked loan, but the company since has seen others that have a different set-up. The market would benefit from guidance about how these instruments are structured, to ensure robustness for investors.
Birth of a standard
As the first corporate issuers entered the green bond market in 2013, the Climate Bonds Initiative (CBI) and the International Capital Markets Association (ICMA) sought to create a voluntary set of guiding principles for participants.
Initially, both frameworks focused on the processes to follow when issuing green bonds: how issuers should describe the allocation of proceeds to investors; how a second opinion should be obtained; and how they should set about reporting in a transparent way.
To kick-start the market, it was helpful to have a simple structure that would reassure investors and facilitate the uptake of green bonds, without being overly prescriptive about the use of the finance.
As the market expanded, questions related to the use of green bond proceeds — their so-called “content” — have inevitably arisen: Which projects will qualify in specific sectors? Where should the boundaries be set? Where should classifications lean towards green or social bonds?
Both CBI and ICMA — along with input from banks and other stakeholders — subsequently have refined the standards to encompass more detail on the content. But the principles remain voluntary, meaning issuers don’t always follow them. And if standards become too prescriptive around content, the market will cease to cater to the full range of investors that want to participate.
Green funding incorporates a wide spectrum of investors. This includes investors with dedicated mandates for green bonds, investors with diversified portfolios that include pockets of green and investors who find green bonds attractive but don’t have a dedicated mandate in place.
These three groups are looking for varying shades of green, and they may hold themselves and the companies they invest in to differing standards. For instance, those investors with dedicated green mandates are more likely to put issuers under greater scrutiny.
But there is a fine balance to be maintained between what investors want and expect, and what issuers want and need. In reality, industries are moving at varying speeds towards becoming more sustainable, and they face quite distinct challenges along the way. Within the investor community, there are a range of perceptions about standards and the various investment opportunities available.
For example, in the real estate sector, a host of certifications encompass different levels of attainment for green buildings. Following the U.S. Green Building Council’s LEED rating system, constructors and developers can seek to attain a platinum, gold, silver or certified rating. Within ING’s building portfolio, we have found sufficient opportunities to allocate only to platinum assets. But where investors can’t find those opportunities — or perhaps can’t access them — they may need to explore lower-rated assets that could be suitable.
Similar conversations are taking place in the green loans market — and ING is part of a group of lenders working with the Loan Market Association (LMA) to develop global standards. These group discussions included whether to define in detail which assets would qualify based on how funding proceeds are being used, or whether standards should focus on process while providing guidance on the quality of assets. This has resulted in a greater focus on process, while allowing flexibility where the use of proceeds is concerned.
I recently spoke with Clare Dawson, chief executive of the LMA, who noted, “With any new market, establishing a general framework for the product such as the Green Loan Principles (GLPs), which we recently launched, is beneficial as it helps create a common understanding of what people are looking at. We will be seeking to develop the GLP further to accommodate a wider range of loan structures, including revolving credit facilities, to maximize the number of borrowers able to take out green loans.”
While issuers and investors have managed admirably with a voluntary patchwork of existing frameworks to date, a new set of commonly adopted standards is key to the continued expansion of green markets. If these standards put the emphasis on process over content, it should create better conditions for green markets to thrive in future.
Leonie Schreve, Managing Director, Head of Sustainable Finance ING
(this column is first published in GreenBiz.Com)