In the context of climate crisis, some see sustainable debt market instruments – green bonds, sustainability bonds, sustainability-linked bonds, transition bonds – as a “green” way out.
The most common and well-consolidated among these sustainable debt market labels are green bonds. Green bonds consist of debt equities issued by firms or public entities and aim at financing so-called “green” projects which seem to embody the sought-after sustainable financial product.
However, with little supervision, green bonds cover a multitude of realities, including the financing of non-green projects and the emission of bonds by polluting companies. Furthermore, a closer examination of their financial characteristics reveals that they are not different from standard bonds and simply serve to make greenwashing easier. Despite these many flaws, green bonds are expected to keep growing, and the new generation of sustainable obligations is repeating the same mistakes.
To make green and sustainable bonds real decarbonization tools, it is necessary to ensure that the companies issuing them are committed to a 1.5°C trajectory and not active in the most polluting sectors.
As for sustainable obligations that are intended to finance companies’ climate transition -sustainability-linked bonds and transition bonds -, they should be based on the issuer’s commitments. Only companies that have adopted detailed absolute decarbonization objectives on all their activities in line with a 1.5°C trajectory should benefit from them. More specifically for fossil fuel companies, credible objectives must go hand in hand with a commitment to immediately stop hydrocarbon exploration and new oil and gas projects.
1000 shades of green in “green” bonds
The first green bond was emitted by the European Investment Bank (EIB) in July 2007. Until 2013, and the “Green Bond Principles”, there was no real intent to clarify or organize green bond emission. However, these relatively loose and voluntary principles, remain largely insufficient to reduce greenwashing and avoid the use of self-named green bonds to finance polluting activities. Even today, there is no legal definition for green bonds. Indeed, without a single definition, these principles remain unable to guarantee the “green” quality of bonds, as some NGOs and financial actors have often pointed out.
Green bonds have financed controversial projects, such as Hong Kong’s airport and Engie’s dam (formerly GDF Suez), or massively polluting ones, like coal in China. According to the Climate Bond Initiative, that aims at ensuring that projects financed through green bonds are aligned with a 2°C trajectory, from January to the end of May 2020: 66.5 billion of emitted bonds were aligned with the Paris Agreement and 90.1 were not.
Since 2018, the European Union is working on “Green Bond Standard” to reinforce the transparency, quality and credibility of green bonds. Despite the fact that the EU Commission is considering a legislative side for this work, these principles, that suggest the alignment of investments financed through green bonds on the new green taxonomy, remain fully voluntary.
Green bonds: a marketing tool?
The objective of green bonds it to contribute to develop green projects. Green bonds are earmarked for climate or environmental projects but are backed by the issuer’s entire balance sheet. The underlying idea is that these projects are more difficult to finance and that specific mechanisms are useful to incite companies to develop more green projects.
Concretely, a green bond should be emitted at a higher price than a similar standard bond. Investors would pay for a “green promise”, in other words, a “greenium” for the emitter, which implies that investors integrate non-monetary benefits in their decision making. Thus, the bond issuer can raise money at a cheaper rate. However, there is no conclusive evidence of the existence of such a “greenium”. For instance, Ivar Ekeland and Julien Lefournier’s study of green bonds reveals that green bonds and standard bonds are emitted in similar conditions, there is no “green bonus”, and they are negotiated at similar prices on the secondary market. Therefore, without any “green bonus” for emitters, green bonds seem to be powerful tools for greenwashing.
Emitters can use these bonds to hide their polluting activities while investors can use it to justify the presence of companies in their portfolio. The financial players do not say otherwise. Nor do issuers talk about financial benefits to justify the use of green bonds. Indeed, the Climate Bond Initiative indicates that the benefit from green bond emission are to “highlight green assets/business”, a “positive marketing story”, to “diversify the investor base” and the possibility to “join up internal teams in order to do the investor roadshow”.
Green bond’s credibility will not be ensured without a strict certification process based on the quality of the project and of the emitters’ commitments. Only green projects with demonstrated ecological benefits should be financed. Furthermore, these bonds should be reserved to emitters engaged on a 1.5°C trajectory and not involved in the most polluting sector and activities (coal, fossil fuels, air transport sector, among others).
Sustainability-linked bonds (SLBs) are used for general corporate finance, but they have interest payments tied to a set of pre-defined Key Performance Indicators (KPIs). If the issuer fails to meet these KPIs, they will pay a penalty to investors in the form of a slightly higher coupon (interest) rate.
2021 has seen the number of sustainability-linked bonds (SLB) explode. After the first issuance of an SLB in 2019, they have been gaining notoriety ever since as they respond to some of the main concerns from issuers and buyers of green bonds: they offer the possibility to issuers of having a discount in the coupon and they are accessible for companies that do not necessarily have individual green projects. Indeed, contrary to green bonds, which are intended to finance specific “green” projects, SLBs finance the issuing entity as a whole. This means that the company is free to use the money however it wants as long as it achieves predefined sustainability objectives set by… itself.
This flexibility is highly appreciated by lenders and borrowers, and it is praised by some as a way to contribute to the decarbonization of polluting companies. However, this flexibility is in fact a double-edged sword. It’s not just the sustainability objectives and the indicators to measure them that must be ambitious and meaningful to the issuer’s activities – rather, the company’s entire strategy must be aligned with what science recommends for achieving the 1.5°C target. Several recent issuances demonstrate that even highly destructive companies can label their bonds as “sustainable-linked” by only committing to marginal efforts to improve their own performance, or peer-to-peer performance. This is the case for TotalEnergies, Enbridge, Albioma, JBS and Rome airport.
Far from supporting polluting sectors’ transformation, SLBs risk being used as another greenwashing instrument. It is up to banks and investors to conduct a comprehensive assessment of the companies they intend to support. As shown by several recent examples, Second Party Opinions (SPOs) are in no way sufficient to validate the sustainability credentials of an issuance and the reputational risks for the financial institutions involved.
Another financial tool that appeared in recent years is “transition bonds”. According to AXA, one of its main promoters, the goal is to finance “transition” projects of companies that are “brown today” and “cannot emit green bonds for a lack of green projects” but have “an ambition to transition to green in the future”.
These obligations have not been picked up by the market, principally because there is a lot of confusion about what would qualify as a “transition” project. Moreover, it is highly risky as emitters are not required to prove their commitment to a green transition and the added value of financed projects is especially difficult to assess in a context of rapid technological evolution. For instance, the first issuance of transition bonds, by AXA and Crédit Agricole, announced at the end of 2019, included gas projects in Asia. Indeed, transition bonds have been largely used to finance gas projects, relying on the old argument that gas is a “transition fuel”. This argument could not be more wrong. Gas can emit as much greenhouse gas (GHG) as coal and recently became the biggest GHG emitter in the EU power sector. Moreover, global gas production must be drastically reduced to limit global warming to 1.5°C and European infrastructures and plants are already overbuilt to respect this objective. Scientists stress the urgency of reducing methane emissions if the world is to meet its climate goals.
Transition bonds seem to only add confusion. It is hard to prove that the financed projects will actually be aligned with the objectives of the Paris agreement, and they do not consider the issuers’ overall climate strategy.
To be credible and contribute to the world’s climate targets, any sustainable debt market instrument from a carbon-intensive sector must be limited to companies that have adopted short-, medium- and long-term objectives of absolute emission reductions, aligned with a 1.5°C trajectory.