The ins and outs of green bonds

Green bonds are making their way into the mainstream market—and are poised for another record-breaking year. In 2017, an estimated US$128 billion to $155 billion in new green bonds were issued globally. For 2018, analysts expect that number will be surpassed.

It’s time to learn how these potentially climate-saving securities can work in your clients’ portfolios.

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“It’s sort of a no-brainer” to offer clients green bonds, when their prices, returns and structures are similar to those of traditional bonds, and when they offer the additional environmental benefit, says Amy West, head of sustainable finance for TD Securities in New York.

For a bond to be considered green according to international standards, issuers must put the money raised toward initiatives such as energy research, renewable resources, light rail, energy-efficient buildings, or other projects designed to lessen humanity’s impact on the environment.

The bonds can be issued by countries, corporations and financial institutions, and they’re often tied to particular green projects. That could mean a wind farm, for example. Similar smaller projects can also be bundled into one asset-backed security.

The majority (75%) of green bonds currently outstanding globally are investment-grade, says Sean Kidney, CEO of the not-for-profit Climate Bonds Initiative, in London. Those bonds represent about US$900 billion.

Green bonds are priced like any other bond of similar structure, duration, credit rating and issuer, says Kidney, and they have the same coupons and repayment requirements as vanilla bonds.

However, clients could mistakenly perceive the green bond market as volatile because they hear about green start-ups struggling, says Kidney. The reality is the bonds are “an entirely different [kind of] issue,” and could fit in a defensive portfolio, he adds.

Regulation, data streams still developing

One of the biggest challenges of investing in green bonds is figuring out just how green they really are, says West. Then, you have to decide which environmental projects to fund.

Most issuers voluntarily follow the Green Bond Principles, which are published by the International Capital Market Association. These govern the use and management of proceeds, project evaluation and selection, and reporting.

Under the principles, issuers are encouraged to explain why their projects qualify as green, explains Kidney. And, every year, issuers voluntarily report how they’ve managed funds from the bonds and how their projects are going. Currently, about 75% of issuers get their reports certified by a third party, such as Canada-based Sustainalytics, says Kidney.

Stephen Whipp leverages that practice to evaluate green bonds. “If advisors want to double-check, it’s a lot easier than it ever has been,” he says. He’s managing director of responsible asset management at Stephen Whipp Financial, part of Leede Jones Gable, in Victoria, B.C.

There are a few basics to check, and that includes whether the bond’s green purpose is embedded within the offering documents, says Jason Milne, vice-president of corporate governance and responsible investment for RBC Global Asset Management, in Vancouver. If the purpose is in the offering documents, there’s a legal requirement for the issuer to use the funds to that end. This type of legal standard is typical in the U.S., U.K. and Canada.

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Advisors can also look to Moody’s when scrutinizing green bonds. The credit ratings agency conducts Green Bond Assessments, which are initiated by issuers who want to assure potential investors. The voluntary checks look at five factors, including whether money is going toward a sustainable cause, such as clean water, biodiversity or renewable energy.

Of the 30 bonds Moody’s has evaluated so far, 28 have scored in the top tier, while two have scored GB2 (very good), says Matthew Kuchtyak, an analyst in Moody’s Investors Service’s Green Bonds and ESG office in New York. The bonds are ranked from GB1 (excellent) to GB5 (poor).

However, it’s important to recognize that Moody’s GB assessments are separate from traditional credit ratings. Kutchtyak explains that the GB assessments are “not related to an issuer’s underlying credit; GBAs can be assigned to transactions with credit ratings or transactions without credit ratings.”

Also, he says it’s difficult to get data that would allow a comparison of the environmental impact across geography, sector and project. For example, while some countries—including India, Indonesia and China—have mandatory rules through securities regulators, what’s considered a green bond in China might not pass for one in Canada, warns West. “For example, in North America, new large-scale hydro, by-and-large, is not considered green. In China, it might be […].”

Kidney notes there are cases where bonds aren’t labelled as green but do fit the criteria. In fact, a 2017 report estimates that unlabeled green bonds are worth about US$674 billion.

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Accessing green bonds

Since green bonds make up less than 0.5% of the global bond market, demand is far outstripping supply. This makes buying them difficult for advisors.

“When we see them, we grab them. Institutional investors grab them up real quick [and that] doesn’t leave much, if anything, for the retail market,” says Whipp. As a result, “We’re getting them from secondary markets: if Canada Pension Plan decides to sell off some of theirs […] then we can get them. […] It took us a year to get them the first time,” he adds, and he typically finds opportunities once or twice a year.

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Whipp mostly buys Ontario- and Quebec-issued green bonds, but they make up a small part of his clients’ bond portfolios.

Rather than hunting for opportunities, you can turn to mutual funds or ETFs. “Those kinds of vehicles are very useful for getting regular investors some exposure to the green bond market,” says Milne.

Kidney says such funds follow green bond indexes, such as the S&P Green Bond Select or the Bloomberg Barclays MSCI Green Bond Index. The Climate Bonds Initiative also works with index and fund providers who want to offer products.

Still, it’s up to firms and their advisors to ensure a fund that holds green bonds meets a client’s expectations. Whipp suggests reviewing all holdings, not just top positions, before making client recommendations. For example, he uses Sustainalytics’ ESG scores to analyze corporate bonds.

He also suggests sharing the project list with clients and asking if they feel strongly for or against any of them, says Whipp.

Also read:

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Manulife becomes first life insurer to offer green bond

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