US$2 trillion rainbow of ethical debt sows investor confusion

Record demand for sustainable finance spurs green, blue, brown bonds

New York

GREEN bonds. Blue bonds. Brown bonds. Environmentally-conscious investors may soon be able to buy a different colour of asset every day of the week.

Record demand for sustainable finance is spurring this rainbow of debt types by governments and companies, to fund increasingly specific ways of mitigating climate change. While green bonds - which pledge their proceeds to finance wind farms or solar parks - are the dominant species, some of these labels have so far remained relatively niche.

That is set to change as a market now worth over US$2 trillion develops rapidly, and as financial engineers create new ways to brand such debt. The greater choice is a boon for the growing cohort of specialist funds with ethical mandates, yet also creates more due diligence in an asset class already lacking clarity thanks to a lack of uniform standards.

"It is confusing," said Taimur Hyat, chief operating officer for PGIM, adding more universal rules and less fragmentation would be "extremely helpful" for PGIM to use its US$1.5 trillion in assets to support the transition to a greener planet. "Clear guidelines will also avoid the risk for the perception for any greenwashing in the industry."

It is only five years since the world's first green sovereign debt was issued by coal-reliant Poland, to help transition to a lower-carbon economy. Now, the emerging spin-offs include blue bonds to fund marine projects; brown or transition bonds for industries too dirty to do green; nature bonds for biodiversity; and carbon neutral to achieve net-zero emissions. Then there are also social bonds to help society and sustainability-linked bonds (SLBs) to set organisation-wide targets.

Chinese banks issued their first blue and carbon-neutral bonds in recent months. Junk-rated companies in Latin America are joining a European boom in SLBs, given signs they can get lower borrowing costs as well as boost their image. Pakistan is seeking debt relief by offering nature-performance bonds to rewild land this year, while the World Bank may debut wildlife conservation bonds to protect rhinos in Africa.

The European Union has already broken market demand records with its social bonds. Government stimulus to recover from the pandemic, together with a raft of net-zero ambitions, could "turbo-charge this trend and contribute to a sharp rise in sustainability-linked loans and thematic bonds in 2021 and 2022", said Gabriel Wilson-Otto, global head of sustainability research at BNP Paribas Asset Management.

Competing rules

The increasing fragmentation is at odds with calls by regulators for comprehensive standards to shed light on the credentials of borrowers and their offerings. There are signs that global policymakers are coordinating steps to address the problem.

US President Joe Biden's administration is planning a US green finance framework that should start to take shape by June, according to people familiar with the matter. The US and Europe could have an identical set of rules that determine what counts as green investment, French Finance Minister Bruno Le Maire said this month.

And China is also working with its European counterparts to announce a common green taxonomy this year, to define and classify green projects. That issue will be discussed at October's Group of 20 meetings in Rome.

"It is acknowledged that the plethora of thematic labels in the market leaves room for confusion," said Esohe Denise Odaro, chair of green, social and sustainability-linked bond principles at the International Capital Markets Association, which is the most widely followed so far. "Ultimately, it is the decision of an issuer how to brand their bond. Investors are more concerned with the underlying integrity of the bonds."

Even in Europe, where sustainable bonds make up more than 20 per cent of this year's sales, there are no set definitions on what constitutes a green project. Individual countries have created their own as they push ahead with issuance before the EU's rules come out. While these are expected to be rigorous, there are concerns that member states will not have to adhere to them.

The Asia-Pacific region is even more prone to fragmentation. The Monetary Authority of Singapore is consulting on a potential green taxonomy for South-east Asia, even though neighbours Malaysia and Indonesia already have their own plans. China, too, has a catalogue of acceptable projects that stress the need to tackle the nation's particular ecological and resource pressures.

Spoiled for choice

The proliferation is at least providing environmental, social and governance investors with a broader array of assets than ever before.

"We are delighted to increasingly be spoiled for choice in the fixed income space, as for many years this asset class lagged in its attention to socially-responsible investing," said Ron Bates, managing director and portfolio manager at 1919 Investment Counsel. Analysing the different types is not that different from investors traditionally reviewing the tenor ratings, and liquidity of every new deal, he said.

But to gain broader acceptance to tap global capital, the market may ultimately need to become more streamlined. Transition bonds were touted as having huge potential to help oil companies move into renewables, yet there are still few such deals so far. Some firms are sticking to green bonds - despite the scrutiny that entails.

And within green bonds, there is also a myriad of shades - light to dark green - as a new breed of ratings companies try to give investors greater clarity on just how kosher the offerings are.

"If you want to tap into the mainstream capital markets, you need to go where the mainstream investors are," said Christopher Kaminker, who leads the sustainable investment team at Lombard Odier Investment Managers, referring to the established green bond market. "We know it's proven that it's mainstream and scalable." BLOOMBERG

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