Montage of car and wind turbines
Analysts are worried the rapid expansion of the green bond market will allow companies to issue debt that is environmentally and socially responsible in name only. © FT montage

The rapid growth of the green bond industry is fanning suspicions that some debt is environmentally friendly in name only, encouraging investors to ignore the label and focus on the credentials of the issuer instead.

The green bond market has grown from almost nothing a decade ago to roughly €660bn in outstanding debt today, and is forecast to hit €2tn by the end of 2023, according to research by NN Investment Partners this month. But the Dutch asset manager also found that 15 per cent of such bonds are issued by companies “involved in controversial practices that contravene environmental standards”.

As the trend for investing based on environmental, social, and governance (ESG) principles moves into the mainstream, fund managers are increasingly looking past the label to the entire business of the borrower — and questioning whether it makes sense to divide their activities into green and non-green portions. 

“We don’t buy a bond because it’s green, but because the company is,” said Tom Chinery, a corporate bond portfolio manager at Aviva Investors. “And when we meet with a company that is selling a green bond, the first question we ask is if they are doing anything they wouldn’t be doing anyway.”

Column chart of Cumulative global issuance of green bonds ($bn) showing Green bond sales have exploded

Mr Chinery gives the example of car companies selling green bonds to fund development of electric vehicles. “To us that’s business as usual. Every car manufacturer on the planet should already be doing this,” he said.

In the headlong dash to sell green bonds, some issuers have raised eyebrows. Saudi Electricity Company, a state-owned monopoly in the oil-rich Gulf country, raised €1.3bn from a green bond sale last month to invest in the installation of smart meters across its grid.

Chris Bowie, a portfolio manager at TwentyFour Asset Management, said that if a bulk of an issuer’s business is in “dirty” industries, “and they are asking you to finance the clean bit, I’m not sure it’s really influencing them to change their behaviour.”

Mr Bowie added he would not hold Saudi assets in ESG-focused portfolios based on the country’s overall weakness on various ethical and sustainability metrics.

“You can see why some investors get quite cynical,” he said. “You are scratching your head thinking ‘really? How did they get that [bond deal] away?’ You can’t just tick boxes with these things.”

Green bonds issued by the Australian state of Queensland have also been targeted for what has been termed “greenwashing”. While the projects being funded by the bond are environmentally friendly, such as to preserve the Great Barrier Reef, the state’s massive coal business is not, said Ulf Erlandsson of the Anthropocene Fixed Income Institute, an advocacy group. 

“Queensland’s expansionary coal policy is directly in opposition to all you’re trying to achieve with the green bonds,” he said. “We declare that as a clear greenwash.”

Even if investors are happy with the issuer’s profile, they worry that green debt is simply a means to relabel investment that was already taking place, providing little incentive to the issuer to change its behaviour in service of fighting climate change. And if a government or business backslides on its commitments, bondholders typically have little power to hold them to account.

“Green bonds are a gentleman’s agreement saying that we expect an issuer to do what they say they’re intending to do with the money,” said Mr Erlandsson. “There’s usually no legal hardcoding in the bond contract saying that we have some legal recourse in case they don’t do what they’re supposed to do.”

In 2018, Mexico’s government decided to mothball a new airport being built in Mexico City, intended to be more energy-efficient, that was funded by green bonds. Although the project was cancelled, it did not trigger any sort of default on the debt. Some ESG indices have since expelled the bond, but it is still on the market — and investors just have to take Mexico’s word that the proceeds are being used for environmentally friendly purposes.

Some ESG investors are instead looking to “sustainability-linked” bonds and loans. Unlike green bonds, these products do not specify how an issuer should spend the money. Instead they reward the borrower when they improve on pre-determined metrics, such as reducing emissions, or punish them with higher interest payments if they miss those targets.

Sustainability-linked bonds
IssuerSectorTotal issuedTarget
Enel Energy$4.9bnIncrease in renewable energy capacity
SuzanoPaper and pulp$750mReducing intensity of carbon emissions
NovartisPharmaceuticals€1.85bnExpanding access to medicines in low and middle-income countries
ChanelFashion€600mReducing carbon emissions at the company and in its supply chain
Source: Climate Bonds Initiative, FT research

“There’s a lot less wiggle room,” said Joshua Kendall, ESG analyst at Insight Investment, highlighting the increased coupon for missed targets. “That is within the prospectus and that is legally enforceable so if an issuer doesn’t meet a sustainability target the investors will get a reward for that.”

These products are not perfect. Mr Kendall highlights the ESG scores provided by specialist providers such as Sustainalytics, which can be “a bit of a black box”. Investors “lack the sufficient information to know whether it’s a metric that is achievable, or stretching”, he added.

There have only been a handful of sustainability-linked debt issuances so far. But Mr Kendall believes the segment has the potential eventually to surpass the entire green bond market. “Businesses recognise that it isn’t just simply about building wind farms,” he added. “It’s about ensuring that their overall strategy is more sustainability aligned.”

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