Green bonds, greenwash, and risk: how to tame the new Wild West

What makes a green bond green? A cynic might say the easy answer lies in the word “green”: take a bond, put the word “green” before the word “bond,” and congratulations—you have created a green bond. In reality, to sell it you have to explain why you prepended “green” to “bond.” Here you could refer to the International Capital Markets Association’s Green Bond Principles, which lay out voluntary disclosure guidelines for issuers.

According to the ICMA’s GBPs, a project eligible for financing with a green bond could include—but is not limited to—any of the following:

1. Renewable energy.
2. Energy efficiency.
3. Pollution prevention and control.
4. Environmentally sustainable management
   of living natural resources and land use.
5. Terrestrial and aquatic biodiversity
   conservation.
6. Clean transportation.
7. Sustainable water and wastewater
   management.
8. Climate change adaptation.
9. Eco-efficient and/or circular economy
   adapted products, production technologies
   and processes.
10. Green buildings which meet regional, national
    or internationally recognised standards or
    certifications.

That’s a familiar, and rather depressing, litany of same-old, same-old. I say depressing because I am familiar with the actual results of these measures.

Define “default”

For example, Germany went hard on item #1—renewable energy—and accomplished little other than astronomically high electricity prices. German grid electricity is no cleaner today than it was prior to the multiple waves of billion-Euro federal support for renewable energy that began in 2000.

The plot below shows the carbon dioxide intensity per kilowatt-hour (CIPK) of German grid electricity versus that of Ontario, from the mid-1990s to a few years ago:

Note the massive support for renewable energy that the German government gave to the RE sector, and note the result. The German CIPK curve started above 500 grams in 1996, and has stayed there ever since.

Now, let’s say that those four waves of RE fiscal support from German taxpayers (and ratepayers, through extremely generous Feed-in Tariffs) had been financed not through mandatory taxpayer/ratepayer largesse but voluntary investment in green bonds. Would those bonds be in default? Clearly the “green” part of them would be—the aim was to reduce CO₂, and clearly the financing did not achieve any appreciable CO₂ reduction.

So what would have been the upshot of this massive default?

Nothing. There is nothing in existing green bonds, no consensus, no provision anywhere about what constitutes a default on a green bond. Everybody knows what constitutes a conventional bond default—the issuer stops paying the coupon and the bondholders are out some portion of their original investment. But a green bond default? It’s the wild west. There is no requirement for a green bond to live up to any standard, other than to finance a project that somebody labelled “green.” No requirement, and no penalty if the security fails to achieve whatever green objective allegedly made it worthy of the label.

I was at the Bloomberg Sustainable Business Summit last week in Toronto. One of the panel discussions took up exactly this subject, the growing equation of Green Bond with greenwash. A 2017 review of the green bond investment space said

Risks of greenwashing stalk the asset class and contribute to many of the decisions and developments in the market. Financiers who have a genuine interest in facilitating “the great transition” build self-governance mechanisms into green bond infrastructure to insure the bona fides of a given bond. These assurance mechanisms are to mitigate the risk that proceeds of green debt will be spent on some thing considered “un-green,” thereby doing reputational damage to the issuer and the nascent asset class as a whole.

But there’s an additional, and I would argue much bigger, risk in this class—the risk that the proceeds of green bonds support projects that have no effect on emissions reductions. The innumerable projects that make up Germany’s vaunted energiewende are squarely in this category. There has to be something more than the word itself that ties “green” to the security.

The Bloomberg summit panelists seemed a bit frustrated that after more than a decade of hype, there still is no consensus on the subject. I don’t blame them. Ten years after the first green bond, these securities are still just bonds that have the word “green” in front of “bond.” Germany’s energiewende ticks all the boxes in what might in the popular mind be considered “green” but that appears to be it.

And Germany’s actual achievement, as shown in dotted line in the plot above, appears to be the textbook definition of what should be meant by default when it comes to green bonds. Unless and until issuers of green bond debt explicitly tie green results to their securities, this is going to stay a problem, and greenwash will stay a most appropriate descriptor for these assets.

Defining success

The solid curve in the plot is Ontario’s CIPK. As you’ll note, it rose through the late 1990s to just below 300 grams—high for Ontario, which as I write this can boast a CIPK of less than 54 grams. I want that 54 grams to be zero grams, and that is what Ontario should aim for. But at least we’re not Germany. Our 54 grams is only one-tenth Germany’s truly disgraceful 500. The salient point is that the late-1990s spike up to close to 300 grams brought Ontario uncomfortably close to Germany, and caused a political crisis in this province. Unlike energiewende proponents, Ontario actually cares how much carbon garbage it throws into the global atmosphere.

The provincial Liberal Party won election after promising to phase out coal, the fuel whose increased use after 1995 caused the CIPK spike. The Liberals made good on their promise, by continuing the effort begun under the predecessor Conservatives, of replacing coal with nuclear—the very same nuclear units whose removal from the grid caused the crisis in the first place. It worked, immediately. Note how the solid-red Ontario CIPK curve drops after each nuclear unit comes back into service.

Had Ontario’s nuclear revival been financed through a green bond, that bond would have performed exactly as promised. The issuer could have specified exactly how much CO₂ each dollar invested would have taken out of Ontario’s provincial GHG inventory. The bond investors could literally have taken that promise to the bank, and they would have been satisfied they had placed their money wisely. The issuer would have had no worry about loss of credibility due to facile greenwashing. Nobody could accuse them of anything other than financing the massive reduction of CO₂.

The fact that no current green bond makes a similar promise with such precision constitutes a serious risk for issuers. We are in a climate crisis, and we have to start massively reducing CO₂. Finance—investing—is how we will accomplish this, but right now finance is proving utterly unequal to the task. Greenwashing is a dismissive term today. It might become a more serious term tomorrow.