The green bonds market needs to maintain integrity while growing

With more and more companies recognising and acting on the risk from climate change in their portfolios, they are beginning to look for alternative assets, which often don’t exist at sufficient scale.

The emerging green bonds market provides a big opportunity and needs to grow, but maintaining its environmental integrity is crucial. This was my takeaway from last week’s World Bank conference in Barcelona, Innovate4Climate, a global dialogue of government, multi-laterals, business, banking and finance leaders focused on shaping the next generation of climate finance and policy instruments.

The state of climate finance

Following the Paris Agreement, the money spent by government on climate change mitigation and adaptation projects — climate finance — has grown in importance and in awareness. Most importantly though, the private sector has started to embrace the topic.

While we can be positive that the dynamics are picking up, we’ve still got a long long way to go. As the motto of the conference went, we need to “shift and unlock the trillions”, or in other words, turn all of our financial flows green.

Not enough alternative assets

I think the dynamics are promising, but how you reach the mainstream remains a challenge. It’s one thing to understand what the risks in your portfolio are, trying to shift your investment, but the very crucial part is having enough new activity, enough new investment opportunities in the low-carbon resilience space.

The green bonds market is one opportunity that everybody’s enthusiastic about, because it’s a new kind of asset class at a level that is relevant to some of the big investors. However, demand completely outstrips supply in that space. The question is: how we can grow that market and mobilise other new assets?

The green bonds market

At Innovate4Climate, I moderated a side event on the topic. We had participation from a broad range of people  in the field — Patrick Bürgi from Southpole Group; Igor Shishlov from I4CE, a think-tank on climate economics; Lisa Wong from Affirmative Investment Management, a dedicated green and impact bond fund management company, and Björn Bergstrand from Kommunivest, a public financial institution with a large track record in issuing green bonds.

Everybody agreed that we need to both ensure the future growth of this market and that increasing its environmental integrity is crucial. There was also agreement that it is important to differentiate between defining what is green at the outset of including projects in a green bond and then reporting on the green performance of the underlying assets over time.

There was disagreement, however, on how to get there.

Difference of opinion

Some were in favour of stricter and more generally applicable standards, and drew on experiences from the early and contested years of the carbon markets and worried about crises in the market stemming from less green projects being labelled as green. Clearer and widely acceptable standards would reduce complexity and remove the search costs on the investor side.

Others stressed that leading market players will continue to innovate and drive standards higher (with others adopting) while a top-down standard applicable to all kinds of projects would reduce the willingness to go beyond these. Investors would, therefore, not engage more with the actual investments and underlying assets, which was seen as a clear plus.

Furthermore, there was a fear that introducing onerous additional requirements at this time would create too much of a financial burden to green bond issuers reducing the much-needed dynamics on the supply side.

The truth, as always, probably lies in the middle – increasing transparency and standardisation where possible while not dis-incentivising innovation and differentiation, and keeping transaction costs low. One idea coming from the audience in this regard was to think about how to deal with different shades of green and explore development of an acceptable rating.

Climate-KIC has kicked-off an exploratory project with Southpole Group, its partner, to survey the market with respect to environmental integrity. This work will include the development of a set of options for further strengthening the growth and integrity of the market, resulting in recommendations and proposed actor coalitions to take this forward.

Blockchain

Another topic that came up at Innovate4Climate was blockchain — an even more nascent market. Discussion was around how can make a difference in transparency and reduce transaction costs, enabling the market to simplify.

Ranging from a keynote by Alex Tapscott, co-author of one of the leading books in the space, and side events, it was clear that the market is keen to explore the application options of this promising technology both on the policy and the private sector side.