Global listed green bond issuance topped US$82bn in 2016, around 92% the volume of issuance seen in 2015, according to the Climate Bonds Initiative – and the market has shown no signs of slowing. Moody’s estimates global green bond issuance – including instruments linked to energy efficiency, carbon capture, and other ‘grey’ areas in the broader spectrum of green bonds – could top US$200bn by the end of 2017.
European issuers, mainly financial institutions and corporates, took an early lead in carving out the asset class for investors, but emerging markets – led by China specifically – have made great strides over the past year and a half: Poland (the sovereign’s €750mn 2022s) , Costa Rica (Banco Nacional de Costa Rica’s US$500mn 2021s), Philippines (AP Renewables’ PHP10.7bn 2026s), Morocco (MASEN, BMCE Bank), Colombia (Bancolombia), Latvia (Latvenergo), Brazil (Suzano, Fibria), Mexico (Mexico City Airport Trust, Mexico City, Nacional Financiera, Rotoplas), India (Axis Bank, Greenko, Hero Future Energy, NTPC, PNB Housing Finance, IREDA, ReNew Power) and China, where a wide range of financial institutions, energy companies and real estate developers have tapped the market.
During that period, an increasing number of investors and asset managers have launched dedicated green bond funds covering both emerging and developed market assets – Sweden’s AP2 pension fund, NN Investment Partners, Natixis’ Mirova Fund, BlackRock, VanEck, and Amundi to name a few.
A Tale of Two Funds
French asset manager Amundi made history earlier this year after it launched the world’s first broad emerging market green bond fund alongside the IFC, the private sector arm of the World Bank. The US$2bn Green Cornerstone Bond Fund – in which the IFC is investing about US$325mn – is aimed at attracting private investment into the climate-aligned bonds and developing the sustainable finance asset class in emerging markets globally.
“Private investors frequently have both the capacity and appetite to invest in climate-smart projects in emerging markets, yet they lack the proper tools to make investments happen,” the IFC stated upon the launch of the fund in April. “The global market for green bonds has expanded rapidly in recent years—totalling more than US$100bn in 2016. But few banks in developing countries have issued such bonds. IFC and Amundi expect the new fund to encourage more local financial institutions to issue green bonds, by increasing global demand and building local markets.”
The IFC is a veteran in emerging markets and has invested some US$15bn in renewable energy, energy efficiency, and climate-friendly real estate projects across a range of EM countries, but the recently launched bond fund targets financial institutions in particular, with many that have so far issued green bonds clustered in China, India, and Mexico.
There are three main components to the Green Cornerstone Bond Fund’s investment process. The first centres on traditional credit assessment techniques – not unlike those deployed on any emerging market debt fund.
The second focuses on a deep analysis of the credit entity from an environmental, sustainability and governance (ESG) point of view. The Fund’s managers – which in Amundi’s case includes, among other stakeholders, classic emerging market debt investors, credit analysts, ESG specialists – focus on continuously evaluating and allocating ESG scores to each entity based on their asset portfolios and activities, in part leveraging the analytical models developed by the IFC among other multilateral development institutions (which, generally, lead in this space).
The final component of the investment process involves green bond selection and management, which is influenced by a range of factors.
“This classic type of ESG investing involves the exclusion of poorly rated names. If the name is downgraded to below a certain level in terms of its ESG score, side then we will divest,” explains Sergei Strigo, Head of Emerging Market Debt at Amundi Asset Management, one of the stakeholders managing the Green Cornerstone Bond Fund.
“We are ensuring that the bonds we are buying for this fund adheres to the highest possible standards in terms of ESG, which today is the Green Bond Principles. We are constantly trying to gain visibility on specific uses of proceeds to ensure we can avoid any controversy through annual impact monitoring and securing secondary opinion by recognised independent third parties.”
BlackRock’s approach to the market is fairly similar. Though it doesn’t explicitly focus on emerging markets, or financial institutions, it does consolidate the expertise of a wide range of stakeholders outside the traditional credit analysis space.
BlackRock has a Climate Solutions team led by Ashley Schulten, who sits within the Portfolio Solutions Group, which will provide analysis and opinion on issuances. Each green bond programme introduced to the market is evaluated both by its conformity to the Green Bond Principles as well as the degree of environmental benefit that can be gleaned from the information provided.
This evaluation is then provided to a group of fixed income portfolio managers that are active in the green bond market as they consider the other characteristics that drive’s the asset manager’s investments – namely credit risk and pricing. Eligible green bonds are then tagged on an internal risk management platform as investible assets.
Going Deeper is a Problem
A big driver of funds’ bid to gain deep insight into the use of proceeds is that end investors – life insurers, pension funds, wealthy philanthropists – are increasingly asking for this . This might be less of an issue for many funds with a broad mandate, both existing or prospective, which in many cases seem satisfied when they see a ‘green’ stamp of approval from a third-party provider. But for those taking these kinds of investments seriously, digging deeper is a must, and in emerging markets, that can be quite problematic because many issuers simply aren’t geared up to collect that kind of data. Historically, there hasn’t been the need to – but that is slowly changing, often due to some combination of regulatory and reputational reasons.
Gauging the impact of these investments, on carbon emissions or other sustainability objectives, is even more difficult for asset managers, which has a knock-on effect in terms of the insights they can deliver to their investors.
“It is often the case that the data third party providers get from potential issuers in terms of reporting on use of proceeds is superficial at best, which makes it challenging for them and as a result for us to gain any real insight into where the funds are going,” Strigo says.
“In terms of ESG, I would say that the vast majority of green bonds out there simply don’t meet our standards,” he says. “Some issuers are trying to become better at providing more robust reporting on use of proceeds and [ESG] impact, but many have yet to see the benefit. That’s where we’re trying to work with issuers, and show them that improving their ESG rating has a direct impact on their medium to long-term prospects.”
Part of the challenge, for investors and the wider industry, is the lack of standards around impact assessment. Mathematical models to determine the impact of a solar farm on carbon emissions are much more robust and straightforward than, say, determining how a new wastewater treatment plant will impact rural pollution, or how new technology deployed in an agribusiness setting (where yields are variable) will influence air pollution. The further away use of proceeds stray from energy, the harder it is to qualify, quantify, and distinguish between ESG benefits. For investors, being able to take a nuanced view on ESG impact will become increasingly crucial as investors, and regulators, become more demanding.
“[Approaching the market using our technique] has enabled us to provide portfolio impact reporting on some of our green bond investment funds,” Schulten says. “As a market standard develops for impact reporting, we hope to be able to differentiate the “greenness” of different green bond programmes.”
