The world's most polluting countries are tackling climate change through the power of financial markets, by embracing the fledgling green bond market to finance billion-dollar green projects and meet internationally agreed sustainability goals. Once an obscure, self-regulated corner of the bond market, regulators in some countries are now issuing formal rules around green bonds in anticipation of record growth. By Farah Khalique.

Climate change is arguably the biggest challenge facing the survival of the species. Global warming is sharply rising - severe droughts, storms and rising sea levels are a common occurrence.

"Despite endless talks on the climate, emissions are going up. It's grim," says Sean Kidney, co-founder and chief executive of not-for-profit Climate Bonds Initiative.

Governments, activists and NGOs have long tried to tackle the problem, but now there is a new crusader: the green bond investor.

Kidney says: "This is where green bonds [come in], there is something we can do."

The green bond boom

Socially responsible investors are champing at the bit to buy into so-called 'green bonds' - bonds that fund projects that have environmental or climate benefits, such as wind farms and electric cars.

These bonds are typically issued by governments and multilateral development banks, but also increasingly by global companies, utilities and banks. The Climate Bonds Initiative is working on mobilising the $100tn bond market for climate change solutions. It also provides bond certification, to give climate bonds a green stamp of approval, and compiles bond issuance data.

Back in 2007, a mere $800m worth of green bonds was issued by multilateral development banks, according to statistics provided by the World Bank Treasury. By 2015 that figure had ballooned to over $45bn; this year over $46bn has already been raised by the likes of Apple, Bank of China, the European Investment Bank and Toyota.

When the Chinese owner of London Taxi Company - Zhejiang Geely Group - issued its first $400m green bond in May to help develop zero-emission cabs, it was six times oversubscribed by eager investors.

Frederic Samama is deputy global head of institutional clients at asset manager Amundi, which has more than $1tn of assets under management.

He says: "Asset owners are entering the game of tackling climate change by aligning their portfolios with climate change. These new players can be a game changer."

Socially responsible investing is of increasing importance, as institutional investors such as pension funds seek to show how much of their investments are ethical.

China - the world's largest source of carbon emissions - is fuelling the green bond boom as its government prioritises environmental protection. The air quality of many of its major cities fails to meet international health standards. Last November at the UN Climate Change Conference in Paris, China promised that its CO2 emissions would peak around 2030 and be cut per unit of GDP by 60-65% of the 2005 level.

Ma Jun, chief economist at the People’s Bank of China research bureau, estimates that China will need to invest at least $320bn per year in green initiatives and projects over the next five years to meet its sustainability goals. 

Traditional financing options have historically been able to cover only 15% of this requirement, hence China's enthusiastic uptake of green bonds. China has prioritised green finance for its G20 presidency, and its recommendations on green finance are on the agenda at the G20 meeting in Hangzhou this September.

The seeds of regulation

The Chinese government has implemented a legal framework that allows organisations to issue these bonds, says Paul Davies, partner at law firm Latham & Watkins.


The People’s Bank of China (PBOC) and the National Development and Reform Commission have published green bond guidelines. Linked to the PBOC guidelines, the Green Finance Committee of China Society of Finance and Banking also released the Green Bond Endorsed Project Catalogue, which sets out the boundaries of what is and is not considered “green.” 


Furthermore, a green bond pilot was also launched on the Shanghai Stock Exchange. These initiatives stem from the country’s five-year plan that includes measures to expand the green bond market, including $46bn of estimated issuance in 2016 alone.


It is expected that the country's National Association of Financial Market Institutional Investors (NAFMII), which is in charge of bonds issued by financial institutions and corporations, will publish regulations in the next few months. The standards and definitions overall will then cover 90% of the bond issuers, says Davies.

"We anticipate that there will be a significant wave of corporate green bond issuance following the release of these regulations. It is expected that NAFMII will then release local government or “municipal” green bond guidance, resulting in Chinese onshore green bond municipal issuance,” says Davies.

Meanwhile, India's Securities and Exchange Board finalised its official green bonds requirements earlier this year, which include requirements such as disclosure of use of proceeds in annual filings. However, some important aspects remain voluntary in both India and China - in India, it is only optional to employ third party certification of the bond to authenticate its green credentials.

Indeed, China and India aside, established practices in the green bond market remain entirely voluntary. The nascent green bond market has been largely self-regulated, with the establishment of the widely accepted green bond principles from the International Capital Market Association (ICMA).

The US and European markets are completely voluntary, says Nicholas Pfaff, senior director, market practice and regulatory policy at ICMA.

"We update the rules on an annual basis, so there is little time lag between market developments and the evolution of green bonds."

The four principles cover the bond proceeds, the process for evaluating and selecting a green project, how the proceeds are managed and reporting on the use of proceeds.

ICMA defines green bonds as "any type of bond instrument where the proceeds will be exclusively applied to finance or re-finance in part or in full new and/or existing eligible green projects", and that are aligned with the aforementioned four core components of principles.

Christopher Flensborg, head of sustainable products and product development at Swedish bank SEB, is one of the early pioneers of the green bond market. He believes the principles have their strengths and weaknesses.

"It's a starting point and gives a common way of working. The weakness is that it's a document for many different stakeholders; it's a not a leadership document but rather a reference," he says.

Fifty shades of green

ICMA's definition is widely accepted, but nevertheless there is still no globally accepted definition of a green bond. There is appetite for clarity on what constitutes a green bond, admits Pfaff.

Some bonds inevitably are less green than others, fuelling concerns of 'green-washing' from investors. A polluting company might issue this type of bond to improve its ecological credentials, while on the other hand there are also some genuinely green issuers that don't want to issue green bonds because of the additional costs.

"Sometimes we think the green bond market sends the wrong signal, by helping polluting companies and penalising the good guys," says Samama.

Bonds have been issued to fund "clean coal" projects in China, which aim to improve the emissions efficiency of coal-fired power plants. This is permissible under Chinese rules, however this would not satisfy more robust standards such as the Green Bonds Principles or the Climate Bonds Standard.

It would be hard to expect that the definition for what should be supported by green bonds be homogeneous globally, says Heike Reichelt, head of investor relations and new products at the World Bank Treasury. Investors have different expectations in different countries and markets.

"But I am convinced that people investing in green bonds are working towards the same ultimate goal – they want to support projects that make a positive impact on the environment and thus on society," says Reichelt.

Timothée Jaulin, associate in investment solutions engineering at Amundi says that investors need to really investigate what is behind a green bond issue to avoid green-washing.

"We try to engage the market and issuer to go further in terms of transparency by assessing the impact of the project they are financing."

Impact reporting is paramount to ensuring the credibility of the green bond market, to ensure that issuers are spending the bond proceeds as promised.

Tanguy Claquin, head of sustainable banking at Crédit Agricole CIB, says it is an ongoing debate.

"How do you measure and verify emissions? There are different approaches in environmental finance to evaluating, assessing [and] measuring the efficiency of green projects," says Claquin.

The World Bank Treasury released its core principles and recommendations in December, highlighting the need for more transparent reporting.

There is also a nascent debate about offering tax incentives for green bonds, at which point there would be a need for a regulatory definition of what constitutes a green bond, believes Pfaff.

Pfaff says: "From that definition, we may possibly move towards having elements of regulation, but we don't see that happening in the near term."

The future of green bonds

Discussions are ongoing about potential subsidies for issuers, and whether green assets should have a different weighting under banking and insurance regulations, which would offer a capital cost advantage. There is also debate about setting up targets for public pension funds to have a certain percentage of funds invested in green bonds.

"However, nothing is imminent," says Pfaff.

China's official guidelines could inspire other emerging market countries and developing countries to issue similar rules, and build up their green bond market. Green bonds issued in emerging markets are a good opportunity for investors to find yield and show commitment to social good, says Amundi's Jaulin.

The next wave of innovation in green bonds could come in the form of Islamic bonds, known as sukuk, predicts Isabelle Laurent, deputy treasurer and head of funding at the European Bank of Reconstruction and Development.

"We have seen some move towards green sukuk. There will continue to be innovations; the way we view green becomes much more embedded in everything we do," says Laurent.

The World Bank has issued some structured bonds, including several green bonds that were linked to equity indices. The next generation could involve investors not only taking an interest in the proceeds of the bond but also willing to take on some of the project performance risk, predicts Reichelt.

Despite the exponential growth of the green bond market, it has its drawbacks that are yet to be addressed. There is no central database of issued bonds, meaning that analysts have to trawl through data from a number of sources to draw a complete picture.

"Our portfolio managers would love access to a [central] database where everything is available, but that doesn't exist yet. Analysts have to look at each individual bond," says Jaulin.