Fifty shades of green bonds

Don’t worry this blog does not contain any erotic language but is about fixed income bonds. However bonds are not dull or boring investments and since 2008 there are even ‘sexy’ green or climate bonds. Greenness aside, such bonds are indistinguishable from any other investment-grade “plain vanilla” security. They carry no extra costs: investors are not exposed to the risks in the projects that are funded by the bonds. Nor do they profit if those projects, which typically include renewable-energy initiatives and reforestation schemes, do well. So why bother to invest at all? The proceeds are invested in environmentally friendly project, so besides a financial return, a social/environmental return is embedded too for investors. The first green bond was issues by the World Bank in 2008 and the market has developed rapidly to an outstanding notional of about $40 billion. During the first four years of its existence, the green bond market was dominated by a few multilateral institutions and development banks. Corporate issuers have only recently entered the market, but have contributed in an impressive way to its exponential growth. Since France’s Air Liquide launched its “social” bond in October 2012, twenty-five corporate green bonds have been issued, together amounting to over $13 billion.

The Economist published in 2011 (Climate Bonds, A dull shade of green; a modest, but important, addition to climate finance; ) the following: “Reducing the risks of climate change is not a technological problem. There are many ways to generate electricity, drive cars or grow crops without emitting much carbon dioxide—but they are expensive. According to the International Energy Agency, $13.5 trillion must be invested in low-carbon energy by 2035 to reduce emissions. That sort of money can be found only on capital markets. Yet investors’ appetite for green schemes is unproven”. But there’s a lack of standardization, too, including 11 different names for “green bonds”. And what constitutes “greenness”, or the risk of green washing? To grow this market successfully we should avoid a very “pale” green one – where the lowest possible hurdle rates/standards have been used to determine “greenness” and the market becomes pool of bonds with low environmental impact but high PR value. Although a consortium of leading investors has recently put together Green Bond Principles (“GBP”), these are voluntary.

Is it green? A few questions ( ; Green Bonds: the future of sustainability financing) to address the issue;

  • The issuer has listed several categories of eligible green projects” in its pricing supplement, but are all those categories really green?
  • Will the issuer really spend the money on green projects? Are the proceeds really “ring-fenced”?
  • Will the issuer actually report to the public on which projects received the proceeds?
  • Does the issuer have a second party opinion?
  • Are bonds issued by a “pure green” company or project or pool of loans automatically green bonds?

To tackle these issues the GBP Voluntary Process Guidelines for Issuing Green Bonds were published in 2014 (, and contained the following four components:

  1. Use of Proceeds
  2. Process for Project Evaluation and Selection
  3. Management of Proceeds
  4. Reporting

They also included a paragraph about assurance in order of increasing rigor, and gave the following suggestions:

  • Second party consultation
  • Publicly available reviews and audits
  • Third Party, independent verification/certification (i.e. like the voluntary carbon credit market)

If you read the details of the GBP it becomes clear that this might be very cumbersome and expensive for issuers to be compliant with the principals. Corporates can also just issue normal bonds without the hassle and pay exactly the same coupon. Alternatively they can communicate their “greenness” via their Sustainability Reporting. The same can be said about institutional investors, besides the normal credit research the analyst and portfolio manager needs to do, it is a lot of work to determine if the green bond passes the test of risk/return and GBP (or ESG/SRI) criteria (which is part of their fiduciary responsibility). This could seriously hamper the growth from a marginal market to a mainstream market.

A possible solution is to introduce Green Ratings next to Credit Ratings. A credit rating is an evaluation of the credit worthiness of a debtor, especially a company or a government. The evaluation is made by a credit rating agency of the debtor’s ability to pay back the debt and the likelihood of default. The credit rating represents the credit rating agency’s evaluation of qualitative and quantitative information (including climate risks) for a company or government; including non-public information obtained by the credit rating agencies’ analysts. Credit ratings are not based on mathematical formulas but credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government. The credit rating is used by investors that purchase the bonds issued by companies and governments to determine the likelihood that the government will pay its bond obligations. A poor credit rating indicates a credit rating agency’s opinion that the company or government has a high risk of defaulting, based on the agency’s analysis of the entity’s history and analysis of long term economic prospects.

Although credit rating agencies were bashed – rightly so – after the 2008 financial crisis (because of flawed statistical models which did not assume the possibility that housing prices could decline materially, and a conflict of interest issue because only the issuer is paying the credit rating fee), the principle of a applying a third party issuing a Green rating seems efficient and effective at first sight (assuming both issuer and investor are paying for the service, and the provider is using a rigorous methodology for deriving Green ratings).

The three main credit rating agencies use the following labels to communicate their credit assessments.


Green Ratings could apply a comparable methodology and labeling to express the “greenness” of the issuer or bond. I am not sure if we end up with “fifty shades of Green”, but the market needs more standardization and differentiation to evolve and become mature. The bond market cannot operate without credit ratings, because many institutional investors have credit rating guidelines in their investment policies.

More research, thinking and debate needs to be done to understand if and how Green Ratings are possibly the Holy Grail for unlocking  the necessary growth of the Green bond market to fund the trillions needed to invest in renewable energy, energy efficiency, sustainable waste management, sustainable land use, biodiversity conservation, clean transportation and clean water.


2 thoughts on “Fifty shades of green bonds

  1. Hi Claudia, thanks for sharing this.

    It is indeed very promising that various initiatives has started, primarily driven by impact investing.

    Examples are:

    Certified B Corporation: B Corp certification (also known as B Lab certification or B Corporation certification) is a private certification issued to for-profit companies by B Lab, a United States-based non-profit organization. To be granted and to preserve certification, companies must receive a minimum score on an online assessment for “social and environmental performance”, satisfy the requirement that the company integrate B Lab commitments to stakeholders into company governing documents, and pay an annual fee ranging from $500 to $25,000 (

    Global Impact Investing Rating Systems (GIIRS): a comprehensive and transparent system for assessing the social and environmental impact of developed and emerging market companies and funds with a ratings and analytics approach analogous to Morningstar investment rankings and Capital IQ financial analytics. (

    Impact Reporting and Investment Standards (IRIS) has developed and maintains a database of standardized definitions for describing social and environmental performance.

    But as described in the “The power of Impact investing” (Judith Rodin, 2014): while GIIRS and IRIS are emerging as leading tools, the quest to find the perfect means of rating social and environmental impact is not over. Ultimately, however, assessing social and environmental impact often involves value judgments that are difficult to capture in hard data alone (similar as credit ratings, but even more challenging). Other systems have emerged along the way like Pulse, SROI, FTSE4Good and MSCI rank larger companies on their ESG performance.

    In my view the challenge is to get “Green Ratings” institutionalized in the mainstream financial world especially linked to fixed income bonds. The bulk of the financing will be needed in the form of loans instead of equity. Perhaps well established parties like credit ratings (although they have been heavily criticized) could step in this space and strategically reinvent themselves (partly) to anticipate and drive this most needed transformation.


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