Opinion

To Thrive, Green Bonds Need Standards for Environmental Impact

After a period of rapid growth, sales of green bonds—debt issued to finance projects with an environmental focus—have slowed. In a Financial Times op-ed, Yale SOM’s Todd Cort and co-author Cary Krosinsky write that the industry needs standardized methods for assessing the environmental impact of a project.


Originally published in the Financial Times on November 4, 2015.

Two news stories hit this autumn that, at first glance, had little to do with each other. First, in September came a report on a slowdown of green bond sales. After more than tripling between 2013 and 2014 to more than $36 billion, the brakes suddenly came on. Issuance for 2015 as of September was less than $30 billion.

A couple of weeks later, Volkswagen admitted to tampering with emissions on its diesel cars. On October 11 news broke that the European Investment Bank, which had loaned about €4.6 billion to Volkswagen for research into low emissions technology, had launched an investigation to determine whether Volkswagen had used the money appropriately.

These stories share a common thread: due diligence of environmental impacts attributed to debt financing. Put simply, a lot of money today, in the form of bonds and loans, is moving toward projects, research, and products that claim to have an environmental benefit.

In theory, this money is helping the world while providing a little payback to the financiers. In reality, virtually nothing is known about the environmental impact of these loans and bonds. The results are twofold: scepticism among green bond investors and issuers about whether the market is “worth it,” paired with a predictable slowdown in green bond issuance; and the potential for misappropriated funds.

In light of this uncertainty, different groups have developed standards to assess the environmental impact of green bonds. Companies such as DNV GL and Cicero now work with issuers to assess the potential environmental impact of their green bonds; these outside companies then issue a “second party” statement on their findings. While simple and effective in principle, a number of thorny issues remain.

First, these assessments measure the potential for environmental benefit, not actual benefit. In fact, standards are generally geared toward the broad class of project rather than its specific benefits. For example, a wind farm might be considered “very green” even if the wind turbines never turn.

Second, there is no standardised method for conducting the assessment. Investors and the public must therefore rely on opaque and sometimes proprietary methodologies as assurance that their investments are indeed helping the environment through the proposed finance mechanisms.

Two examples highlight the difficulties with measurement. Earlier this year, TD Bank issued a $454 million bond earmarked for “contributing to a low carbon economy.” High-minded, yes, but that leaves a lot of wiggle room around which projects might qualify. Are energy efficiency projects at an oil sands processing plant, or natural gas infrastructure, “contributing to a low carbon economy”?

Unilever ran into similar issues in March after it issued a $250 million bond to “reduce the company’s carbon footprint.” With such lack of definition, some have called the bond no more than a marketing tactic. More significantly, there is no recourse for investors if Unilever decides to invest the money in other projects with no carbon benefit.

Such muddiness around the assessment of green bonds is perhaps unsurprising. For investors, the risk of “little environmental impact” has always been secondary to the risk of low returns. It is not accidental that due diligence on risk of return is a highly standardised method with large brand names such as Moody’s on the front lines, while due diligence of environmental impact remains a scattered approach led by companies you have probably never heard of.

But this is going to change, with four key factors on the near horizon: the large rating agencies are moving to standardise due diligence for environmental impact; investors are tiring of the claims made on green bonds with little evidence and corporate issuers are hesitant to pay the costs incurred to label a bond “green”; green bonds promise to be a major topic of discussion at the climate conference in Paris; and in the wake of Volkswagen, we will be hearing of more examples of “green loans” with no evidence of “green impact.”

The convergence of these factors will either move us toward a standardized approach to “green due diligence,” or kill the green bond movement and relegate lending for environmental benefit to the purview of governments. Let’s hope for the former.

Lecturer in Sustainability

Lead Consultant, Principles for Responsible Investment (PRI), Climate Change Asset Owner Strategy; Lecturer, Yale College and Yale Climate & Energy Institute