Hype
It seems
that Green Bonds are the latest finance fashion. With the emphasis on mitigation and
adaptation to climate change, the issue of financing the necessary activities
has been brought to the forefront. One of the major stumbling block for the Paris
Agreement was that of financing, particularly for developing
countries to catch up. In this
environment Green Bonds have emerged as one of the simplest solutions to finance
projects that can contribute to achieve the Sustainable Development Goals and
those of the Agreement. It is almost
becoming the panacea. Issue green bonds
and the problem will be solved. In this
brief article we want to discuss the potential gap between green financing and
green projects, which may lead to greenwashing and suggest some measures to
close the gap.
Green bonds
are issued to finance green projects, but the link between issuance and impact is
not automatic. How green is the project financed by a green bond? Will the green bonds really finance green
projects that have the alleged impact?
With the pressure to appear making progress in closing the financing gap
there may be bonds that are “colored” green
or bonds that start green and lose their color during the execution of its projects.
Most progress indicators are stated in terms of
green financing made available and not on the impact of the green
projects financed. The numbers related
to issuance are easy to access and happen early, but the impact of projects
financed is very hard to measure and occurs, if it happens, later. And then
we all forgot about the projects.
One very
good case of emphasis on inputs versus outcomes or impact is the recently unveiled
Green
Pledge, that calls for $1 trillion of green bonds to be issued
during 2020. But issuance is a necessary
but not sufficient condition to achieve goals like keeping the rise in temperature
below 2 degrees. Finance does not green
the environment, effective projects do. There
is a gap that may be filled with green paint. There is the temptation to label
everything green. One of the most egregious examples is that of France that
issued Euros 7 billion in bonds labeled green to finance items related to the
achievement of the Paris Agreement goals.
These have been and can be financed by regular Treasury debt, but by
bundling those activities around the issue, the debt can be called the “the
largest sovereign green bond” and boast of leadership. There is also the issue of additionality,
i.e. are the new green bonds issues additional financing that would otherwise
not be available? Experience so far
indicates that most issues, like the one of France, were and could be traditional
finance. For instance, what it used to
be project finance for hydropower or renewables us now labeled as green
finance. And not only the hydropower generated but the transmission line now
called green finance. But let’s concentrate on the gap between green finance
and green projects.
It is not
that any issue can be labeled green, it must comply with certain requirements,
the most commonly used being those of the International Capital Markets
Association, ICMA, although there are many others, including those of countries
or groups of countries and, in the near future, those of the European
Union. The
Green Bond Principles of the ICMA require issuers to comply with
requirements under four Principles: 1. Use
of funds; 2. Evaluation and Selection of Projects; 3. Funds Management; and, 4.
Reports.
Under Principle #1 the framework or prospectus must state the types of Projects/activities that will be financed; under
#2 it must state how the projects/activities will contribute to
sustainability and how will they be selected (methodology); under #3 it must state how the funds will be
allocated and managed (governance); and under #4 it must
state that reports will be prepared on the implementation of
projects/activities and that it would be desirable to offer to report on
results and impacts achieved (indicators are suggested for some cases).
In theory,
the Principles cover all aspects that are deemed necessary to assure that the
green bonds are green, but the problem is in their implementation and
verification of compliance with the stated (promised?) goals. In the implementation there are gaps in all
four of the Principles:
1.
Bond´s frameworks
or prospectus: These documents state
how the issue intends to comply with the GBP, but the vast majority of cases include
generalities, the minimum necessary to comply. Priority seems to be to maintain
operational flexibility, to avoid having to disclose more information than
necessary, to avoid potential reputational and, especially, to avoid legal risks. Many will just state the general types of
projects or activities to be undertaken without specifying any details. With
very few exceptions they do not state how the projects or activities will
contribute to the greening of the environment and society, in many cases only the
types of projects and activities are listed.
2. Verification: The compliance of the
framework or prospect with the GBP is verified by a third party, issuing “a
second opinion”, based on “limited assurance” as opposed to “reasonable
assurance”. This opinion is limited to
the verification that all the four principles are addressed in the document,
i.e. the documents says where the funds are to be used, how the projects will
be selected, the governance of the issue and the reports offered. But it an assessment
of compliance with content.
3.
Rating: Some
issuers obtain a rating of the bond regarding compliance with the GBP on some
aspects (transparency, governance, projects proposed, reporting, etc.). S&P
and Moody’s
have developed methodologies. These
ratings do add a level of rigor to the limited assurance of the prospectus as
they evaluate the potential effectiveness of the proposed compliance, not only
if the GBP requirements are described. But
this is still an ex-ante evaluation, based on promises in the prospectus or
framework. No investment has yet happened.
4.
Monitoring: And here is where the largest gaps can occur. The same third parties can be called
on to assess the content of the issuer’s reports. These limited assessments evaluate if the report includes what the prospectus
stated it was going to include (see
KPMG on Unilever). There also
are assessments of the progress in the implementation of the issue, but the monitoring
is limited to assessing if procedures outlined in the framework or prospectus were
followed.
In all of these stages there is no guarantee
that the green bonds led to green projects, only presumption.
Closing the gaps
The single most effective tool to ensure
alignment of intentions with having impact is the social responsibility of the
issuer itself. If we wanted to
regulate all the phases so that there will be guarantees of effectiveness and
impact the regulations would have to be so detailed as to be unyielding, very
expensive for all and all flexibility would be lost. But this does not mean
that the current ones cannot be tightened and still be manageable. The GBPs must be tightened to avoid
generalities, verifications to include assessment of potential impacts of the
projects and activities must be compulsory not optional, and the monitoring
must go beyond stating that the processes followed, their effectiveness must be
evaluated, and more importantly, the impact achieved. Some of the gaps identified above could
be tightened by:
·
Including a justification
that the funds are tapping a market that would not available to non- green projects, that it is not
just a change in denomination. This can
be speculative but combined with the assurance below would lend credibility to
the green finance market.
·
Including detailed
criteria for project/activity selection based on expected impacts, not just
on its vague “green” characterization, as it is currently done in the majority
of cases.
·
Include a description of the expected impacts of
the activities/projects based on agreed upon indicators (for example those of
the SASB). For instance, if it is energy efficiency, what are the quantitative
goals.
·
Requiring a rating or the issue or a second
opinion of “reasonable assurance”, that
includes an assessment
of the compliance of the processes proposed with the detailed selection criteria and an assessment of their potential to
achieve the proposed impact of the projects, not only a limited assurance
that that content of the framework aligns with the GBP.
·
For the project monitoring reports require also
a “reasonable assurance” that GBP have been complied with, that the use of the
funds has been effective and the extent to which the impacts are being achieved,
beyond what is the currently the case of assessing only if the resources were
utilized in the projects and activities proposed, which could have been very
general. Currently a typical statement concludes: “nothing has been called to our
attention that the resources were not used for the intended purposes” (DNV-GL
on Unilever Green bond). As the explosion of the market has been so
recent there are very few examples of impact assessment (see below).
Additionally,
the Principle issuers (ICMA, European Union and others) and the green finance
industry should seek to promote the expertise
and involvement of civil society organizations in the monitoring of green bond
prospectus and projects as these issues are not yet in the radar of civil society organizations that should
demand accountability.
This will no
doubt increase the costs of the issues, but as they usually are in the hundreds
of millions of dollars, the increase would be small in relative terms, and the
gain in credibility high. Accountability for impact is needed. But the
risk aversion of issuers conspires against the effectiveness of the
process.
This is, with some variations, what the
oldest (first issue in 2007 for US$800 million) and largest non-sovereign issuer
of green bonds (US$18 billion in 10 years), the European Investment Bank, EIB, is
currently doing. Granted, this is a
development institution that finances projects by almost US$80 billion every
year and has the expertise to monitor the projects it finances and assess their
results, as it is required to do so by its internal regulations. Also, the EIB is in the business of having
impact, not just providing finance; it has a stake in the project, unlike
commercial or investment banks that are in the business of providing finance
and its stake is in the borrower and not on society. But is precisely the EIB the one that created and
developed the green bond market.
Credibility and impact not just quantity
All of this
is not to imply that green bonds are not an effective and legitimate tool to
promote green development, it is to highlight the potential gap between
issuance and impact, through labeling as green traditional forms of financing
and by financing projects that may not be as green as alleged. The GBPs, while a big step forward, have a
weak implementation that has the potential for greenwashing and for
ineffectiveness. The more pressure there is to issue green bonds, the more
greenwashing.
The emphasis on
amounts of green bond issues is misplaced and can lead to the impression that
amounts are synonymous with transformation.
It distracts from what should be the real concern: the impact of
projects completed. Unfortunately,
memory is very short, and the media is dominated by those that profit from
quantity of issues (investment banks, consulting firms, assurance companies,
even the companies that exploit the publicity) and not from results achieved
(society).
The credibility of the green finance industry
is at stake. At some point the
emphasis will move towards quality not quantity of issues. As socially
responsible investors are demanding that companies demonstrate their corporate
social responsibility and more accountability and want to invest beyond the
simplistic exclusionary criteria (no arms, no vices), the green finance industry
has to move beyond financing projects/activities
that are labeled green to those that are demonstrably green. One day we will be asked: Yes, we complied with the financing goals for
green projects, but global temperatures still went up by 3-4 degrees C. What happened?
