(Refiles to amend spelling of Petheram in 21st paragraph)
* Green bond supply expected to reach US$40bn this year
* Fragmented and voluntary standards lack teeth
* Reputation not enough, investors want compliance
By Sarka Halas
LONDON, July 29 (IFR) - The speed of growth in the Green bond market in the past year is raising serious questions over whether the lack of scrutiny and binding requirements in the sector are storing up problems for the future.
While highly rated supranationals and agencies have been pioneers of the Green market, corporates and banks are beginning to join the fray. Supply is expected to reach US$40bn in 2014, almost four times the US$10.98bn issued last year, according to the Climate Bond Initiative (CBI).
But while many investment banks are keen to push the feel-good product to their clients, there are no international standards defining what ‘Green’ actually means, frameworks are only voluntary, and Green language is lacking in covenants.
“We need strong standards that address how Green bonds are constructed, and standards that assess how the ‘Greenness’ of the bond is reported,” said Sean Kidney, CEO and co-founder of CBI. “Investors have to be able to link the money to the underlying asset.”
Navindu Katugampola, executive director for Green bonds at Morgan Stanley, argues that the market needs to see more granularity, more transparency of how the proceeds are being spent, and more qualification of the impact of projects - for example, the volume of CO2 reduction.
As the market has grown and new types of issuer have joined the trend, a number of sales have left investors scratching their heads.
“Toronto Dominion’s Green bond did not specify an independent reviewer or an auditor. The bank said they were changing auditors and so hadn’t nominated one, but this should have been essential for the bond sale,” said Kidney. “In the end the Canadian bank did undertake to report, but the mechanism was not properly articulated.”
Toyota also raised eyebrows when it sold a US$1.75bn bond backed by its regular fleet, with the aim of using the proceeds for hybrid cars.
GDF Suez was another example, printing a 2.5bn dual-tranche deal, the proceeds of which can be used to fund acquisitions, albeit of Green and renewable energy companies.
As well as the sometimes questionable use of proceeds, the fact there is a multitude of third party agencies acting as independent verifiers using various sets of criteria can also be confusing.
The top external verifiers are DMV, Vigeo, and Cicero, who all have their own guidelines and to varying degrees set standards for the market.
Meanwhile, the CBI also has a set of standards that can be used by investors, while four banks drew up a set of voluntary Green Bond Principles (GBP) earlier this year, which are designed to be industry-wide with ICMA now acting as secretariat.
While it is a start, the GBP, for example, do not set out specific environmental impact targets. Meanwhile, they clearly state that “underwriters of Green Bonds are not responsible if issuers do not comply with their commitments to Green Bonds and the use of the resulting net proceeds.”
“Not everyone will agree on what is Green and when this question is raised it will be an issue,” said Manuel Lewin, head of responsible investment at Zurich Insurance Group. The insurance giant recently doubled its investment commitment to Green bonds to 2bn.
“The market needs to be able to keep its integrity and transparency, but it is not a black-listed process,” said Lewin, adding that Zurich looks at both pre-investment and post-investment, focusing especially on transparency and measurable effects.
At the moment, standards focus on the use of proceeds, process for evaluation, management of proceeds, and reporting, with the latter recommended at least once a year.
The first wave of yearly reporting will start to surface at the end of this year, although German agency KfW could lead the way for more regular reporting after it promised to deliver quarterly reports to investors on the use of proceeds for its first Green deal.
Meanwhile, some question whether the industry needs to go beyond simple voluntary standards.
“Investors have started arguing to us that if a company falls out of compliance, there needs to be some kind of penalty, like an interest rate increase,” said Kidney.
“We think that reputational risk is enough of a deterrent at this stage of market growth, but we’ve agreed we’ll convene a working group on the subject at the end of the year.”
Rhys Petheram, fund management director, Jupiter Fund Management, said that investors would penalise companies if a bond was not deemed to be Green enough, adding that the measurement side of the product was weak and investors were not pushing as hard for clarification.
He added, however, that the subject of penalties needed to be approached carefully.
“There are questions around whether standards should be incorporated into the covenants or not. There is a danger that it could kill the market,” he said. (Reporting by Sarka Halas, additional reporting by Aimee Donnellan, editing by Helene Durand, Julian Baker)