Challenges for institutional investors around green bonds
While an angle on environmentalism can be applied to virtually every asset class, when it comes to bonds, it’s not easy being green.
Super-national organizations, such as the World Bank, pushed forward the creation of these investment vehicles, he says. “They wanted to do these projects and I think we’ve got a lot to be thankful for. And then some corporates started to follow suit. It’s been a pretty positive trajectory in terms of the [assets under management], but the fixed income markets have been growing very fast as well. So people look at the AUM for green bonds and say, ‘This is incredible,’ but the whole market’s been going up.”
Now that the idea has gained major traction among institutional and retail investors alike, further growth will need to come from private enterprise, says Purdie. “It’s incumbent on the corporates to do more.”
But besides simply growing in the amount of debt raised to support green projects, further progress is required to ensure the investments genuinely qualify, in some capacity, as green, and that they stay that way, he adds. “Things need to change a little bit to make sure that these are actually impactful as opposed to just a tick-box exercise and a bit of greenwash.”
Under current regulations, no real mechanism exists to solve for the eventuality that a corporate entity could easily change its mind around what to do with the money raised through issuing a green bond. An investor seeking to gain exposure to an environmentally friendly allocation would then have no recourse to fight against this, says Purdie.
He also notes that, for the bond to be making a significant environmental difference — and therefore justifiably characterized as green — it should be raising money for something the company wasn’t going to be able to do otherwise. In addition, there needs to be standardization around what to do if a project falls through, he adds.
“You have a lot of managers who’ll buy green bonds as a way to demonstrate they’re taking their ESG requirement seriously. And that in and of itself, we think, is not enough. From the issuer side, we’ve spoken to a lot of corporates who’re issuing green bonds and, what we really want to check is, are they issuing the green bond for something they otherwise wouldn’t have done? Because that’s an incremental benefit we want to support. If they’re issuing a green bond, but they were going to do it anyway, they’re only doing it for reputational reasons.”
Solutions to this program include potential mechanisms, like make-whole provisions, whereby the bond issuer would have to buy back the bond at a premium should the terms of what the capital is intended for change, says Purdie. “But the problem with that for me is it’s completely misaligning my objectives, and the objectives of the issuer are then completely misaligned. Because, essentially, if a bond is trading and I know that if they don’t do something [specific] with the proceeds then the bond’s going to go up 15 or 20 points, then secretly, as a bond manager, I don’t want them to do it, because I want to make money for my clients.”
Ultimately, the situation remains somewhat fraught since there’s no standard definition of what’s green, he adds.
“It’s a market that’s developed in fits and starts. . . . I think the market is slowly moving towards standardization, but there are still some companies out there that issue green bonds and they’re not independently verified in terms of what they say they’re going to do. And then I think there are reputational issues for us as investors as well . . . if people look at it and say, ‘Well, we don’t think that’s green.'”
For example, investing in nuclear power could be considered green since, from one perspective, it’s the cleanest energy produced. However, if something malfunctions, the environmental impacts could be massive, not to mention the potential cost of human life, adds Purdie.