A Breakout Year for Green Bonds

Addressing climate change is going to require a lot of investment. The International Energy Agency estimates that the transition to a global low carbon economy will require upwards of US$53-trillion in cumulative investment in energy supply and energy efficiency by 2035. The National Round Table on the Environment and the Economy estimated in 2012 that an “annual investment on the order of $13 to $17 billion” was required in Canada to achieve our climate change objectives.

So, there are large investment needs…but the good news is that we are not starting from scratch. Investment is a constant in our economies, and the tools to orient that investment towards better environmental outcomes already exist.

A case in point is bonds – which can be thought of as IOUs between the issue and investor. You buy a bond, and you receive a stream of income back from the issuer. Bonds, as an investment vehicle, are almost perfectly suited to the needs of a low-carbon economy. Much of the needed investment is in infrastructure, which is capital-intensive and returning a long-term flow of revenues back to bond holders. And bond markets are big: outstanding bonds total over US$150 trillion globally, and the US bond market trades over US$800 billion each day.

Using bonds to achieve environmental outcomes is starting to happen more and more. As detailed in Sustainable Prosperity’s recent report, 2014 has been a breakout year for green bonds, with new issues totalling almost US$40 billion globally. That is the number for what are called “labelled green bonds”, meaning they are explicitly called green by the issuer and have specific environmental criteria built into them. A much larger set of bonds called “climate-themed” bonds captures those that do not have an explicit green label attached to them, but which are designed – in the activities they are used to fund – to deliver environmental outcomes.

In Canada, the green bonds news has been made by three new players. First, the Export Development Corporation issued a US$300 million AAA rated green bond to fund environmental projects. Then, TD Bank issued its first green bond, totalling C$500 million, and finally the province of Ontario issued its first green bond and raised C$500-million as part of its regular financing activities. Ontario plans on using proceeds from their bond to fund the Eglinton Crosstown Light Rail Transit project.

In all cases, the bond issues were over-subscribed, which reflects growing demand for green bonds from investors. In fact, what we are seeing from the investment side are two dynamics: first, “green” investors are seeing in green bonds a way to access an asset class that has not always matched their investment objectives, and second, traditional investors are moving into green investment using a vehicle in which they have history and confidence. For the issuer of the bonds, diversifying the investor base is seen as a good thing as it drives greater demand and higher prices.

As the market has grown, so too have concerns over the potential for greenwashing around the bonds. How can investors be assured that the proceeds generated by the bond are being applied to environmentally-beneficial activities? To address that question, efforts are being made to create standards for green bond activities and transparency. That’s a start, but the stakes are high, both in terms of the investment needed and in terms of the credibility of the institutions involved. Green bonds are building real momentum right now, and we need to ensure that they don’t stumble at the gate. Getting it right on green bonds will go a long way to help us achieve the low-carbon future we want and need.