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Green Bonds Not Generating Enough Green

Investors would be more keen to incorporate ESG bonds into their portfolios if the yields were more attractive.

The market in green bonds has boomed over the past few years, spurred by growing interest among institutional investors in environmental, social and corporate governance (ESG) issues. There is a problem, though. Institutions are on the hunt for yields, and green bonds’ yields often are just too low.

“Some of the issues in the green bond market right now are at such extremely low yields that they’re starting to become uninvestable,” Ulf Erlandsson, Stockholm-based senior portfolio manager at AP4, the 295 billion krona ($34 billion) Swedish pension fund, said at a recent London conference on green bonds held by the nonprofit Climate Bonds Initiative. “For many investors this has become a big issue.”

The problem, say investors, is that too many of the bonds are too highly rated. A hefty $36.6 billion in green bonds was issued in 2014, according to the Climate Bonds Initiative, more than triple the 2013 figure and more than ten times the $3.1 billion issued in 2012. Of these, 45 percent carried a triple-A rating and a further 16 percent were double-A. Because of this conservative risk profile, Erlandsson estimated in mid-June that average yields for green bonds ranged between 1.6 and 1.86 percent, with an average duration of five years.

Erlandsson’s point is echoed by Sean Kidney, CEO of the Climate Bonds Initiative, who told the conference, “Insurers don’t really want triple-A at this stage. There’s not a lot of yield in triple-A. What you want is A– or thereabouts.” Insurers are a key market for green bond issuers.

Colin Purdie, head of global investment-grade credit at £246 billion ($391 billion) Aviva Investors in London, has a solution. “If you really want to develop the market,” he says, “you need more corporate bond issuance.” Corporate issuers can provide more attractive yields.

The size of the corporate green bond market is still small, though it has grown at an encouraging pace since the issuance of the first one, a Skr1.3 billion issue to fund green property development by Vasakronan, the largest property company in Sweden, in November 2013. Companies have since issued €19.5 billion ($22.2 billion) of debt. Recent big transactions include Danish wind turbine maker Vestas Wind Systems’ €500 million offering of seven-year, 2.75 percent bonds issued in March.

A particularly encouraging recent development is the issuance of green bonds by a handful of emerging-markets entities, providing further diversity and yield pickup to the market. In March the Export-Import Bank of India issued a $500 million triple-B bond, maturing in 2022, with a coupon of 2.75 percent.

Yet investors say the green corporate bond market still has a lot farther to go. “We are seeing more issues from emerging markets, but there still aren’t that many,” says Christopher Wigley, Paris-based fund manager at Mirova, the €5.2 billion socially responsible investment arm of French financial services firm Natixis Asset Management. Wigley runs the €70 million Mirova Green Bond Global Fund, which is available only in France, and the €115 million Mirova Euro Sustainable Corporate Bonds Fund, which is 22 percent invested in green bonds. There is, moreover, a problem with some emerging-markets green bonds, he adds. “The ones we have looked at sometimes don’t offer quite so much transparency as developed-markets issues, or don’t offer so much additionality; the green impact is not quite what we want.”

The issue of “additionality” — the sense that a green bond genuinely makes the world a greener place in some small way, versus a bond without the green label — is key to the growth of the market. Investors shy away from green bonds that don’t meet their criteria. “What’s important to many investors is that the project which the green bond is financing has a meaningful impact,” says Wigley. He has, for example, seen cases of companies issuing a green bond to finance a new factory that is more energy efficient than the existing one. “Some investors might say that any new factory will be more energy efficient than an old one, so what’s the appeal of that?” he asks.

But despite these gripes, investors still think the green bond market will continue to grow. Wigley has already seen a recent upturn after the March release of revised Green Bond Principles, which give clearer guidance to issuers on subjects such as the bond’s environmental impact. The Green Bond Principles are published by a group of issuers, banks and investors. “In 18 months to two years, you’ll see more green corporate bond funds coming into the market,” says Aviva Investors’ Purdie. “Once you see those kinds of funds, the expectation that there are enough green bonds will be become self-fulfilling: Treasurers will say, ‘There’s a pool of capital we can use.’”

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