One positive argument for green ‘use of proceeds’ bonds which are, among other things, non-additional for the environment and cost of capital neutral for issuers, is that such labelling (or tagging) could possibly help investors diversify towards ‘green’ without them thinking too much. In aggregate and over time, that might have some benefit for the environment.
Unfortunately, all the current ‘green’ tagging of securities is focussed on new bond issuance wanting to self-identify as green. This accounted for only 2.1% of total new bond issuance globally in Q1 2017 and 0.25% of the global bond market. Many bonds that do not self-identify as green are as ‘green’ as their officially labelled equivalents.
This focus on new issuance is perhaps understandable. After all you need to start somewhere and new issuance generates fees for the organisations involved, including those that label and verify whether a bond is green or not. But the market opportunity for this small but increasingly vocal industry is not with new issuance, but accurately tagging all issuance – both new and old.
Accurately tagging all ‘green’ securities would enable institutional investors to shift allocations in the right direction over time. This would help them avoid some of the risks associated with ‘brown’ investments and the threat of stranded assets. The same exercise in bank loan books, though necessarily more idiosyncratic to individual banks, would help the banking system reduce its exposure to flood risk and energy price shocks, among other things.
The objective – to systematically tag and back-tag all new and outstanding issuance of securities and loans ‘green’ or ‘sustainable’ – is a major undertaking that should not be underestimated. Fortunately, some of the methodologies that have been developed to tag and assess the greenness of new issuance could be applied to back-tag outstanding issuance, for example the Climate Bond Standard and methodologies for voluntary and compliance carbon offsets, as well as CICERO’s Second Opinions and S&P’s Green Evaluation Service. Where appropriate, the best of these methodologies should be applied to the challenge of back-tagging.This should largely be a private sector endeavour. But policymakers, regulators, and researchers have a critical role too, as has been identified in the newly published interim report from the European Commission’s High-Level Expert Group on Sustainable Finance. The group has argued for a new ‘European Observatory’ to develop common methods and tools to aid the development of greener and more sustainable capital markets.
The focus on new issuance must quickly broaden out to include outstanding issuance.
The Observatory could help to coordinate an international public-private collaboration on back-tagging, making sure the latest methodologies are employed to automate the process as much as possible, ensuring standards are transparent and peer-reviewed, and that changes in the use of assets are considered when determining how green a security or loan is. The expert group also highlighted the need for new labelling standards and a European sustainability label for securities should also consider how to tag both new and outstanding issuance and whether standards and methodologies can be interoperable between them. All these efforts, if tagging is done accurately and transparently to the highest standards, can inspire confidence in ‘green’ assets in our capital markets.
To enable large financial institutions to shift portfolios – whether bonds, equity, or bank debt – from ‘brown’ to ‘green’ we need an effective and reliable way of tagging all issuance. The focus on new issuance must quickly broaden out to include outstanding issuance. The European Commission, through its High-Level Expert Group on Sustainable Finance, has been given a draft roadmap for Europe to lead on sustainable finance. Policymakers and practitioners should now follow it by fostering early wins in robust labelling, data, and standards.
This is part of a series of blogs on sustainable finance and investment by Ben Caldecott, Director of the Sustainable Finance Programme at the University of Oxford Smith School of Enterprise and the Environment and a Senior Associate at E3G.