Shoots of recovery in the green bonds market?
After a difficult year, investors and wider experts discuss whether green bonds will rebound in 2023.
According to data from the Climate Bonds Initiative, in Q3 of 2022 the green bonds market hit the milestone of having $2tn worth of issuances since the first ever such bond was issued by the World Bank in 2007.
However, this news masks the fact that 2022 was a poor year overall for the sector, with a bear market leading to a significant fall in issuances of green, social, sustainable and sustainability-linked bonds down. According to Morningstar Direct data, the Bloomberg MSCI Global Green Bond Index (Total Return) was down 22.7% for the year.
This slump comes in the midst of a wider hit for fixed income, which also showed marked decline in the last 12 months as interest rates rose and rose.
Year in review
Stephen Liberatore, lead portfolio manager for asset manager Nuveen's ESG fixed-income strategies, adds some nuance to the year that was: “2022 certainly was a down year for the market, but I would say it's still relatively strong for labelled green bonds. The lack of issuance was primarily on the social bond side, and that makes some sense because issuance in 2021 was in response to COVID-19 relief efforts.
“There was also a much bigger drop in sustainability-linked bonds and sustainability bonds, which were the larger components of the drop, whereas green bonds had a more solid year.”
According to data compiled by Citi, global volumes of sustainable bonds stood at $763bn as of 16 December 2022, down 23% on the same period in 2021 ($990bn).
In June of last year, the European Parliament proposed extending the European Green Bond Standard to require increased transparency and reporting for the majority of sustainable bonds. Meanwhile, in the UK, the government is currently consulting on bringing ESG ratings providers “within the regulatory perimeter” of the Financial Conduct Authority, which will directly affect areas of green bonds such as second-party opinion providers.
According to Jose Maria Ortiz, managing director for impact investment at international advisory company the Palladium Group, some previously launched green bonds will not pass updated thresholds, both decreasing the quantity but increasing the quality of the instrument.
Marc Naidoo, sustainable finance partner at law firm McGuireWoods, agrees: “There was a boom, but now there are increased risk factors and a more sophisticated market with enhanced accountability, so the downturn is more than likely a result of these market factors.”
A difficulty with ESG activity is in proving how it is impacting real-world reductions in carbon emissions, as the data is sometimes hard to procure and there is the possibility of investments simply being diverted to asset managers less concerned about environmental issues. There is also the ever-present spectre of greenwashing, of firms making bold statements that are not matched by concrete activity.
Nuveen and its parent organisation the Teachers Insurance and Annuity Association of America-College Retirement Equities Fund (TIAA) has had to face accusations of greenwashing itself. In October last year, a complaint with 300 academic signatories was sent to the UN Principles for Responsible Investment regarding TIAA/Nuveen continuing to hold significant oil and gas holdings in its portfolio, though the UN PRI has since dismissed the complaint.
However, on the fixed-income side, Liberatore is insistent on the use of raw impact data to ensure that investments are both immune from such greenwashing accusations and can show real-world impact.
“At Nuveen there is a focus on pure raw impact data, but there are different methodologies that the investor can choose. That's why to me, it keeps falling back to transparency and disclosure. You can show the investments made and the dollar amount, plus the outputs, the impact metrics, the equivalencies. Then the investor can make the clear determination of how to view within an overall portfolio”, says Liberatore.
With all the deliberation of best use of data and assessment, David Zahn, head of European fixed income at Franklin Templeton, puts it simply: “The green bond market can be a significant contributor to impacting climate change – but it is only one part of the equation, not the entire solution.”
Too many labels?
Investors looking to put their money towards more responsible or sustainable causes in the fixed-income market can choose from the traditional green bond, or a UN SDG-linked bond, or a social impact bond, or a transition bond, or a “sustainability-linked” bond, or a clean oceans focused “blue bond”, plus a number of yet further labels.
This proliferation of options has long threatened to confuse the investor, and it remains to be seen if the coming year will be one of greater clarity or further confusion for the market. This is a particularly pertinent question given that the introduction of phase two of the EU’s Sustainable Finance Disclosure Regulation – creating a de facto labelling system for financial instruments such as corporate green bonds – has had such a muddled start.
“Whilst some would say that an increase in regulation creates a more standardised market with stricter guidelines, the other side of the coin is that the more regulations there are the more loopholes come into existence that can be exploited. Confusion reigns supreme where there are multiple standards to adhere to, and whilst regulators are trying to do the right thing, sometimes this can be counter intuitive”, says Naidoo.
This confusion makes it harder to monitor the activities of investors looking to reduce the carbon emissions of a portfolio. Morningstar Direct data shows that, for January to September 2022, of flows into European climate funds by strategy type, green bonds were dwarfed by “climate-conscious” inflows, which are funds that “select or tilt” toward companies that consider climate change in their business strategy.
According to Dave Sandor, CEO of sustainability technology firm Allinfra: “Currently, green bonds are generally issued under a variety of standards developed by trade bodies rather than mandatory standards from governments.
“On the one hand, the current voluntary system works well and tough regulations could mean additional effort and cost for issuers, discouraging some organisations from issuing green bonds. On the other hand, the lack of regulation can allow greenwashing to occur, causing doubts around the effectiveness of green bonds among investors.”
Outlook for 2023
All the swirling issues surrounding the green bond market bely the fact that it is still considered a valuable form of investment by many. And there is hope for some growth this year.
“In 2023, on the energy side, we will see a momentum to transform from hydrocarbon energy sources to renewables with a potential boom of green bonds in developed economies related to project finance. On the nature side and emerging markets, the market will struggle much more given the cost of capital,” predicts Ortiz.
“On the positive side for nature we will see many green bonds being structured and issued when markets recover and we will begin to hear about oceans-related ‘blue bonds’ at country level especially in the APAC region, but we will not see much action.”
On the sovereign side there are also signs of a bounce back this year across the world. Austria plans to raise at least €5.1bn ($5.5bn) of green instruments, expanding its green debt offering to money-market instruments and loans, according to its 2023 funding plan. Mauritius is also considering issuing as much as $1bn of social-impact bonds to help fund plans to increase renewable energy production and transition to greener transport.
These nations follow on from India opening to auction its first ever sovereign green bond in January this year.
“We're going to see more sovereign entities come to the market to specifically target their climate commitments. So, from the sovereign perspective, I think we're going to see significantly larger growth going forward,” says Liberatore.