In any future account of the rise of the green bond market, the second half of 2014 will deserve special note. During this period three major financial institutions have launched indexes devoted to the bonds, which governments and corporations issue to pay for alternative-energy infrastructure, public transportation and other projects that combat climate change.
S&P Dow Jones Indices kicked things off in July by debuting two green bond indexes, Bank of America Merrill Lynch released one in late October, and British bank Barclays and index provider MSCI partnered on a family of offerings that launched in mid-November.
The index rush reveals that the financial industry is banking on green bonds’ becoming a mainstream investment as it opens the space to an untapped contingent of buyers.
“What an index does is bring in a whole new class of investor,” says Sean Kidney, co-founder and CEO of the London-based Climate Bonds Initiative, a nonprofit that advocates for broader adoption of green bonds. “It brings in the more-passive investor, which is important to continue to fuel demand for green product.” So far, Kidney says, the bulk of investors have been institutional players like insurers, pension funds and corporate treasuries.
Investors typically require a benchmark against which to measure their own funds’ performance. Phil Galdi, New York–based head of global bond index research at BofA Merrill Lynch, says his firm’s clients had been asking for such a comparison for their growing green bond holdings, so the bank responded with its index. “This helps to legitimize the asset class and build the track record for the asset class,” Galdi notes.
Client demand for indexes has picked up as the number and diversity of green bond issuers have expanded amid a surge of investment. This year has already seen $35 billion in issuance, according to the Climate Bonds Initiative, more than triple the $11 billion total for 2013. Kidney says that in 2015 the annual tally could reach $100 billion.
Although the firms that recently launched indexes see the same bright future for green bonds, in an effort to distinguish their own brand, they’ve each defined and demarcated the asset class differently.
S&P’s offering comprises two distinct indexes. The S&P Green Bond index consists of bonds labeled as green and officially included in the green bond universe that groups like the Climate Bonds Initiative are tracking. The S&P Green Project Bond index holds bonds that are not labeled green but that the firm deems appropriate for inclusion because of their climate friendliness. This offering is for project- and asset-based lending, and most of its bonds are linked to renewable energy projects.
The first index sticks to triple- and double-A-rated bonds, whereas the second will range between triple-B and double-B-minus. The assumption behind launching two separate indexes is that as the green bond market matures and expands, so will the green label.
“The green label is an innovation that has happened in the last couple of years, since the advent of the Green Bond Principles, so we see a number of assets that are accessing pools of capital but are not labeled as green,” says Anadi Jauhari, founder and senior managing director at Stamford, Connecticut–based Emerging Energy & Environment, an alternative-investment firm that specializes in green infrastructure investing. EEE’s credit and research affiliate, InfraCredit, was a consultant on the creation of S&P’s green bond indexes.
S&P also has the broadest qualifying criteria of the new offerings. There are no size or liquidity limits, but a qualifying bond’s maturity must be at least one month. “It’s all inclusive,” says Julia Kochetygova, London-based senior director of global equities and strategy at S&P Dow Jones Indices. “If we really want to tell the story of the whole market, that’s the best approach to take. Otherwise you can always slice it and dice it.”
By contrast, the BofA Merrill Lynch Green Bond index includes only so-called use-of-proceeds green bonds earmarked for a specific project; it doesn’t allow bonds that are pure-play, ones that are issued by a climate-focused company for general capital raising. Its minimum offering size is $250 million for dollar-denominated paper and €250 million ($311 million) for euro issues.
The MSCI-Barclays family of 59 green bond indexes does allow pure-play green bonds as long as the company issuing them generates at least 90 percent of its revenue from one of five climate-focused categories: alternative energy, energy efficiency, pollution prevention and control, sustainable water and green buildings. Eligible use-of-proceeds bonds must also target at least one of those areas. The minimum dollar- and euro-denominated bond sizes for the MSCI-Barclays indexes are $250 million and €300 million, respectively.
“There is a minimum-issue size for inclusion in the index because ultimately we’re looking for this to be an investable or replicable universe,” says Brian Upbin, head of benchmark index research at Barclays in New York.
The overseers of the new green bond indexes say these criteria will probably change over time. The Climate Bond Initiative’s Kidney expects that the market will take a major step forward after a Chinese commercial bank launches that country’s first green bond at the end of this year. By the end of 2015, he adds, China could account for one third of global issuance.
“The market is still in a nascent stage, so some of the market standards and conventions are still evolving,” EEE’s Jauhari says. “There’s still a lack of consensus as to what constitutes green.”