Green bonds explained

Green bonds are an important part of a portfolio that is aligned with the low-carbon transition

Summary

With more than 2,000 investors, with assets under management in excess of USD70 trillion, committed to responsible investing, green bonds provide a relatively easy way to support this ambition.

Since its inception in 2007, the green bond market has grown significantly such that issuance is expected to reach between USD 180-210 billion this year. In terms of total green bonds outstanding this amounted to USD 389 billion at the end of June 2018 (CBI September 2018). A wider definition of ‘climate aligned’ bonds suggests that the total bonds outstanding reached an estimated USD1.45 trillion by mid-2018.

While the growth in green bond issuance was relatively modest in the early years, this has changed since the International Capital Market Association’s Green Bonds Principles (GBP) were developed in 2014 and the Paris climate agreement was signed in 2015.

Allocations to the green bond market have also been supported by an increasing number of investors aiming to align their investments to the United Nations’ Sustainable Development Goals.

Indeed green bonds could be a natural fit with the SDG agenda given the majority of green bond proceeds have been focused towards financing the clean transportation, efficient buildings, energy efficiency, renewable energies, water management and waste management sectors.

Guidelines and principles for green bond issuance have been developed at a country level for example in China, Brazil, Kenya, Nigeria, India and Japan. From a regulatory perspective, China has led the field. In 2014, China established a Green Finance Taskforce and their recommendations were adopted by the Central Council in 2015 which were turned into into green financial guidelines, including for green bonds in 2016. Green bond issuance by Chinese institutions expanded significantly thereafter.

In 2018, attention has turned to Europe, where the European Commission has announced its Sustainable Finance Action Plan. As part of this agenda, a sustainability taxonomy will be developed and adopted before the end of 2019. One of the aims is to help ensure integrity and trust in sustainable finance products such as green bonds.

At DWS, our proprietary ESG Engine implements a framework to assess the ESG risks and opportunities of bonds (at an issuer level) which finance specific ESG related/themed projects. This predominantly covers green bonds, but, aims as well to achieve coverage for blue, social and sustainability bonds as well.

In this article we explore the development of the green bond market and the risks and opportunities ahead. We expect a strengthening of standards for green bonds and the development of methodologies for assessing whether/how green bonds actually reduce carbon emissions. Investors also have a role in encouraging the growth of building related green bonds linked to energy efficiency.

Continued allocation to green bond funds is important to continue the green bond market’s momentum and the wider positive influence it is having within the capital markets, with companies, governments and regulators.

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