domingo, 16 de septiembre de 2018

Closing the gap between green bonds and green projects: Issuance vs. impact


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?

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