Why green bonds need a closer look

What do green bonds do?

There is growing indication that green, socially sustainable bonds deliver environmental and social benefits through a global, diversified universe - but how?

In a nutshell, green bonds finance projects that are focused on a positive environmental impact and that ultimately contribute to the transition to a low carbon economy.

These projects can be quite broad but the majority sit within one or more of these environmental themes: green buildings, sustainable ecosystems, low carbon transport and smart energy solutions. A recent example in Australia was when NAB issued a green bond in May 2022 that specifically financed renewable energy (around 75% of financing) and low carbon transportation (the remaining 25% of financing).

While they are all ‘use of proceeds’ bonds, there are differences between green, social and sustainability bonds: the first two finance environmental and social projects, while sustainability bonds finance a combination of both.

The price of a bond normally reflects the financial risk associated with its issuer – the same applies to a green bond. So, there is no justified structural difference in terms of issue price or financial performance between a green bond and its traditional equivalent. Investors therefore have the opportunity to add transparency and environmental impact to their portfolio without taking additional risks or paying a higher price.

As such, a key reason green bonds are being used in the transition to net zero is their transparency and outcome-driven process – an aspect that is unique to sustainable bonds within the fixed income universe. Investors are also able to access detailed reporting on key performance indicators for the project linked to that bond and subsequently assess the project’s greenness and measure its environmental benefit.

The market itself is highly rated with a current average rating of AA-¹  . The global green bond universe is also split equally between sovereign or sovereign-related and corporate debts with relatively similar sensitivity to interest rates. This is different to conventional government bonds and corporate debt which can have quite a divergence in interest rate sensitivities due to a wider ratings range between the two. 

Why they need the scrutiny

Like any investment and particularly ones that claim to be sustainably focussed, it’s imperative to enter into the detail and ensure issuers use proceeds from green bonds to finance projects that are indeed green.

In our experience, we have found that at least 30% of global green bond issuances don’t satisfy our credibility test. With that, it’s essential to have a rigorous approach to ensure a real environmental benefit and avoid supporting any ‘green washing’. At AXA IM, we have developed our own framework for assessment. This framework not only drives responsible investments towards authentic green projects but also looks to raise the standards of the whole market.

We ask questions such as, does the green bond fit with the bond issuer’s environmental objectives? Will the project have a clear impact beyond the issuer’s business as usual? Do we know that the proceeds will finance what they are supposed to? How does the issuer plan to track the progress of the project and measure impact? These are some of the areas which are critical to analysing a green bond.

In a relatively short period, the green bonds universe has evolved from a niche market, into a credible alternative to conventional bonds. The market’s assets under management, sector allocation and issuer numbers now provide investors with strong diversification options. Additionally, the recognised need to invest in a low carbon transition to mitigate climate impact, along with the societal impacts inflicted by geopolitical turmoil, has shifted the perception of sustainable bonds. For many, they are no longer an option but a necessity in a portfolio.