- The difference between green bonds and traditional bonds is that the proceeds of the former are earmarked primarily for projects with positive environmental benefits.
- No uniform regulation governs this segment as yet, and many a green project turns out to be a sham on closer inspection.
- By applying their own strict criteria, funds can ensure that only truly green projects make it into the portfolio.
The European Investment Bank (EIB) pioneered green bonds with its Climate Protection bond in 2007. Since then, 860 billion US dollars worth of green bonds have been issued, with a further 820 billion US dollars worth expected.
Just a few more weeks and the time will have come: in September, German finance minister, Olaf Scholz, plans to bring the first green German federal bond to the market and raise billions for environmental and climate-protection measures. This is good news for investors who want to invest their money both sustainably and safely. Germany is, after all, one of the few borrowers worldwide with a top credit rating.
Emerging market segment with potential
The German minister of finance is seizing upon an increasingly important trend: financing special projects that benefit the environment. The European Investment Bank (EIB), which launched the world's first green bond in 2007 with its Climate Awareness Bond, set the ball rolling. The EIB has used the proceeds from this bond to support renewable energy and energy efficiency projects, such as combined heat and power plants, expanding district heating and upgrading real estate to improve energy efficiency.
Since then the market has developed dynamically. Last year, more than 200 billion US dollars worth of green bonds were issued worldwide. If we add social bonds and sustainability bonds to this figure, the total is well over 250 billion US dollars. The proceeds from social bonds benefit projects that generate added social value, for example in the health and social services sector. Sustainability bonds finance environmental and social projects and thus help achieve the UN sustainability goals.
Binding standards are needed
The selection of green bonds on offer is expanding constantly, as more and more companies from a wide range of sectors discover this financing instrument. Alongside green bonds, sustainability-linked bonds, such as social and sustainability bonds, are also growing in importance. These bonds have innovative forms whereby the bond conditions are linked to achieving specific sustainability targets. One example is a bond issued by an Italian energy company. If the company does not achieve an agreed quota of renewable energy in its overall energy production mix, it has to pay an interest premium.
The big challenge for investors is to assess how sustainable a particular bond really is. "A uniform and legally binding definition of what green projects are and are not has been lacking up to now," says Christof Breuer, manager of the DWS Invest Green Bonds fund, which made its debut in October 2018. There are voluntary standards, such as the Green Bond Principles published by the International Capital Markets Association (ICMA), but no regulatory requirements.
The European Union did make a start on regulating green bonds at the end of 2019. However, final agreement on what constitutes sustainable economic activity has not yet been reached. The EU aims to develop standardisation for green bonds so that green investments can be compared more easily.
The European Union is in the process of introducing a uniform classification system.
Strict guidelines are necessary to exclude projects with questionable ecological benefits.
Using fund expert know-how
Until that happens, investors have no choice but to do their own checks on how the money is being used - or to opt for a fund solution such as DWS Invest Green Bonds.
Breuer explains the procedure for the DWS fund: "The starting point is bonds that bear a green label according to DWS criteria and have a market volume of at least 200 million US dollars." The fund experts then analyse how sustainable the issuing companies are in terms of environmental, social and corporate governance (ESG) topics. In addition, they talk to the companies to find out which green projects the proceeds from the bond are to be invested in and how they can make an even better job of integrating ESG topics into their business processes. Only then is a decision made on whether to include a bond in the fund. At present, the fund is around 90% invested in green bonds.
So, if you want to combine reliable returns with a clear conscience when investing, the green bond segment is perfect for you. This relatively new market is growing rapidly and looks set to continue to develop dynamically in future. For private investors, keeping track of the market is probably the greatest challenge.