How corporate ESG analysis can make an impact.
The rising popularity of green bonds is a salient indication of the growing enthusiasm for sustainable fixed income investing. Green bond proceeds back climate or environmental projects. With a green bond, an investor can allocate capital and receive documentation that the bond will back projects offering environmental and social benefits. Green bonds may also serve as a starting point for investors seeking to identify issuers that are aiming to operate sustainably. However, in our view, the green bond label is no substitute for bottom-up, in-depth credit research that integrates environmental, social and governance (ESG) factors. Breckinridge advocates “looking before you leap” into green bonds that come to market and exploring strategies beyond green bonds that incorporate ESG analysis.
On the supply side, green bond issuance continues to rise because corporations and municipalities want to meet the growing demand for debt that funds important social or environmental purposes. Statistics include the following:
- Issuers brought $155 billion of global green bonds to market in 2017, up from $93.4 billion in 2016 and $42.4 billion in 2015, per Moody’s Investors Service.
- Issuance is expected to swell to $250 billion in 2018, per Moody’s.
- Varied issuers have taken advantage of the benefits of green bonds (Figure 1), such as the opportunity to attract a greater and more diverse investor base or the potential to appear as a leader in sustainability. For example, in June, Canada Pension Plan Investment Board (CPPIB) announced plans to issue its first green bond, becoming the first pension fund to do so. The bond will back additional CPPIB holdings in renewables and energy-efficient buildings.1
From the demand perspective, investors have eagerly absorbed new green bond issues from both corporations and municipalities. The majority of green bond deals brought to market continue to be multiple times oversubscribed by investors.2 Demand for green bonds largely emanates from the same incentives driving demand for sustainable equity assets, such as value alignment, impact investment or belief that ESG-focused investing can help to manage long-term risks.
The market’s growth has also spawned demand for new green bond indices, which will help track green bond performance as the space matures (Figure 2).
In addition, the market now offers social bonds and sustainability bonds. These bonds are extensions of the green bond market. Social bonds signal that bond proceeds are financing social purposes, while sustainability bonds finance both social and environmental projects. The development of these new classes of bonds illustrates rising interest in fixed income investing that provides capital to beneficial projects.
All That Glitters Isn’t Green
We think green bond growth and other signs of the sustainable investing conviction are certainly encouraging, and new green bonds can often highlight opportunities for investments with solid long-term credit profiles. However, we believe that investors should maintain a balanced perspective on green bonds, as the green bond market is still in its early stages and the discussions about proper labeling are still ongoing.
Eligibility Standards Still Hazy. To begin with, the discussion of what exactly qualifies as a “green bond” is unfinished. Many issuers and borrowers rely on the Green Bond Principles (GBP), criteria created by a consortium of investment banks in 2014. The GBP are process guidelines for green bond issuance with four core components: Use of Proceeds, Process for Project Evaluation and Selection, Management of Proceeds and Reporting. However, the GBP are voluntary guidelines for issuers.
For climate-related bonds, the Climate Bonds Initiative (CBI) generated the “Climate Bonds Standard and Certification Scheme,” which uses rigorous scientific criteria to ensure that “Climate Bonds Certified Bonds” are consistent with the 2 degrees Celsius warming limit in the Paris Agreement (see Fossil-Fuel-Free Investing: Process and Perspective). Many rely on CBI certification to determine labeling. However, CBI certification is voluntary as well.
Some third-party research firms, such as Sustainalytics, perform green bond assessments. Or, in some cases, funds and issuers have crafted their own definitions and standards of green bonds.3
With this lack of standardization, investors do not have an implicit understanding of the criteria green bonds must satisfy, nor a sense of how green bond proceeds will be used to fulfill their green initiatives. Broad-based adoption of a certifying scheme is an important component of the future of the green bond market. Standardization will help investors to better evaluate and monitor the bonds and to have more confidence that the issuance adequately provides corollary benefits.
History Still Limited. History surrounding green bonds is still fairly recent, as the first green bond was issued in 2007,4 and the first U.S. municipal green bond was issued only five years ago.5 While growth in the green bond market has been strong, the size of the global market ($221 billion)6 pales in comparison to the overall U.S. fixed income market ($41 trillion),7 and research into green bond pricing and credit trends is hindered by a shorter time horizon and smaller sample size versus traditional bonds.
Credit, Pricing Impacts Unclear. Many market participants have conducted research on the potential premium required to purchase a green bond versus a traditional bond, particularly given the oversubscription often afforded by green bonds in the primary market. Results have been inconclusive. Barclays research found that green bonds traded 17 basis points (bps) tighter in option-adjusted spread than traditional bonds, as of mid-2015.8 That Barclays research also showed that the premium had steadily increased from early 2014 through late 2015. A different 15-month sample from the Climate Bonds Initiative of more than 60 investment grade bonds also showed evidence of a premium. U.S. dollar corporate green bonds priced on average 22.2bps tighter than Initial Price Talk,9 versus 16bps to 17bps tigher for traditional bonds. However, in that report, some green bonds priced in line with their existing credit curves, while others priced with a tighter or wider spread than expected. In addition, euro corporate green bonds priced within range of traditional bonds.10 Also, in a report specifically focused on muni green bonds, no premium was evident, per Barclays.11
As for green bonds’ place in the capital structure, typically, they rank in line with existing debt of the same seniority and there is no credit enhancement.
These mixed credit and pricing trends for green bonds support our view that prudent green bond investing should include an in-depth evaluation of the risk and return profile of each green bond, considering bond structure and idiosyncratic risks.
Green Bonds Offer Many Positives, But Research Beyond the Label Is Important
Investors can combat these issues and beat fatigue with potential “green washing”12 by performing the same bottom-up credit research process with green bonds that is used in traditional bond investing. Breckinridge regularly reviews green bonds when they come to market, but investments are only made when they meet our standards for structure, pricing and credit quality, among other considerations.13 All green bonds are subject to the same research and investment process that is applied to all our investments. While green bond labeling is largely based on how the bond proceeds will be used, at Breckinridge, we believe that sustainable investing requires looking beyond the use of proceeds. To establish a full picture of an issuer’s sustainable characteristics, it is important to look at each issuer’s ESG profile, as ESG can impact credit fundamentals (see: Looking Beyond Use of Proceeds). Although we appreciate that most green bonds offer transparent reporting and back important sustainable projects, Breckinridge will not forgo return or “pay up” to invest in a green bond.
As green bonds continue to gain traction with investors and issuance spreads across a more global and diversified range of borrowers, more stringent evaluation standards will likely be necessary. Stricter standards will help investors have more confidence that they are investing in a green bond that is truly sustainable, and it could also provide more recourse against green bond issuers that drift away from their green mandates. Still, Breckinridge advocates researching green bonds closely.
Green Bonds Are One of Many Paths to Sustainable Fixed Income Investing
We believe ESG metrics are a powerful tool for managing risks in fixed income portfolios and can help investors better achieve their goals of preserving capital and building sustainable sources of income. In some cases, investors are interested in ESG to align their investing with their values. Investors will vary in their goals and interests in ESG, so their approaches to ESG will vary as well. Importantly, green bonds are just one avenue to sustainable investing. We encourage investors to discuss ESG options with their advisors and to take care in determining the most appropriate ESG approach.
 CPP Investment Board, as of June 11, 2018.
 “GREEN BOND PRICING IN THE PRIMARY MARKET: July–September 2017,” Climate Bonds Initiative and the International Finance Corporation, Q3 2017.
 JP Morgan, as of June 1, 2018.
 The first green bond was issued by the European Investment Bank in 2007.
 The Commonwealth of Massachusetts sold its $100 million green bond—the first ever by any state or local government in the U.S.—in 2013.
 Climate Bonds Initiative, as of year-end 2017; data pulled by JP Morgan.
 SIFMA, outstanding bonds in the U.S. as of 2017.
 Barclays, as of September 2015. Sample universe is the Global Credit Index, a multicurrency index that includes both corporate and government-related issuers.
 Initial Price Talk is indicative pricing provided to potential bond investors at or shortly following the bond’s announcement.
 Study January 2016–March 2017, the Climate Bonds & International Financial Corporation (IFC) with support from Rabobank, Pax and Obvion.
 Barclays Municipal Credit Research, as of June 27, 2018. Included comparisons of two municipal green bonds with similar traditional bonds from January 2017 to mid-2018.
 An issuer overstating or misrepresenting the environmental benefits of a bond.
 As of 7/2/18, a total of 60 green, social and sustainable bonds (based on unique issuers) were held across various client portfolios.
DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.
Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. An investor should consult with their financial professional before making any investment decisions.
Some information has been taken directly from unaffiliated third party sources. Breckinridge believes such information is reliable, but does not guarantee its accuracy or completeness.
Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.