The Emperor Has No (Green) Clothes


We have started seeing a lot of greenwashing within the “green” bonds space. How does one recognize a legitimate green bond?

A shiny new object is popping up in impact investment portfolios everywhere – behold, the green bond. A corporate or municipal fixed income instrument offering both market returns AND positive environmental impact, green bonds have emerged over the past six months as a significant area of new issuance. Corporations are issuing carve-out bonds whose proceeds go to infrastructure retrofits, while munis are hopping on the green bandwagon with bonds targeting clean water improvements, green construction for public schools and affordable housing, and other similar programs promoting forms of clean tech and energy efficiencies.

As impact investors with a long history of supporting sustainability, low carbon footprints, and environmental efficiency, we were excited to see the financial community take notice through the marked rise in green bond issuance, due to the scalability this implies. Finally, financial institutions have found a product that delivers both a competitive return and environmental benefits. This will hopefully encourage further issuance and underwriting of green fixed income products. Hoorah!

However, this euphoria was instantaneously balanced with a creeping sense of dread: financial institutions had discovered green bonds. The marketing machine had found a new angle for pushing product. Bring on the greenwashing. Ugh.

Indeed, we have started seeing a lot of greenwashing within the “green” bond space. Savvy issuers have recognized that branding a bond issue as being green potentially opens it up to a new group of purchasers (impact investors) that may otherwise not give these bonds a second look. This made us wonder: how does one recognize a legitimate green bond from one that is greenwashed?

We spoke to two of our municipal fixed income managers to try and answer this question. The answer, according to Wasmer, Schroeder, lies in the use of proceeds. Bonds that list specific, environmentally beneficial uses of proceeds in their offering documents are likely to be green, whereas bonds listing vague uses of proceeds or which say that proceeds “may” fund environmental improvements are likely greenwashed. Interestingly, we think that few investors bother to read about the uses of proceeds. Wasmer initially evaluates potential green bonds for credit worthiness, and then focuses on the use of proceeds, to determine if the bonds are actually green. Bonds that lack specific uses related to environmentally solid purposes don’t make the cut for green bond investment.

At present, there are no regulations governing what can and cannot be labeled as a green bond. The International Capital Markets Association (ICMA) has created Green Bond Principles that issuers should follow, but this is entirely voluntary. The bad news is that financial institutions are using watered down standards because they can see the demand for green paper. Further, the ICMA obliges issuers to comply with long-term requirements on reporting, which includes use of proceeds, but muni issuers have a longer lag time for the filing of financials compared to issuers of equities or corporate bonds. If a bond was issued in July 2014, for example, the market might not see relevant disclosure until Sept 2015 in reporting. Some issuers have established websites to facilitate more real-time reporting.

Greenwashing aside, we have embraced legitimate green bonds as an excellent source of capital origination for beneficial projects which might otherwise not get funded. Original issuance is one of the few instances where impact investors can connect directly to issuers in the public markets. However, we have approached the broader sector with a healthy dose of caveat emptor due to the current market dynamics.

This approach leads us to believe that some of the scoring methodologies analyzing the impact of publicly traded securities could be tweaked so that investors can more easily differentiate the relative impact of legitimate green bonds. For example, one impact scoring system rates Bank of America Merrill Lynch (BAML) green bonds at 61 (out of a relative scale of 100), but rates regular BAML corporates at 58. We were surprised that the delta between these two bonds was not higher.

Caveat emptor would also argue for acknowledging that, in our broader view of the impact universe, we believe publicly traded securities inherently produce a lower level of impact than can be achieved through direct investing. That said, liquidity and steady yield are key components of a robust portfolio, and these needs are nicely satisfied by legitimate green bonds.

In the spirit of the perfect not being the enemy of the good, we are encouraged to see issuers of green bonds coming to market with the express purpose of creating environmental benefits or efficiencies. Unfortunately, the proliferation of greenwashing seems poised to rise. To that extent, we encourage caveat emptor among investors: read the use of proceeds, and know what you are buying. To paraphrase a favorite fable: a naked emperor is better than one with green clothes.