The green bond revolution

Green bonds are likely to play a key role in how investors switch to clean energy, but is the asset class right for everyone?

Green bonds look set to revolutionise not just the speed at which the world transitions to clean energy, but also how broader bond markets work. The rapid growth of the asset class, which is well supported for continued acceleration, underlines asset owners’ increasing interest in accounting for climate change risk in their portfolios. According to the Climate Bond Initiative (CBI), there are now $694bn in outstanding climate-aligned bonds, an increase of $96bn (or 16%) since the same analysis was conducted the previous year. Within that total, $118bn are “labelled” green bonds – those that have been certified by the CBI to say the funds raised from their issue will be used to finance new and existing projects with environmental benefits. Green bonds saw record issuance during 2015 with $42bn issued, meaning this sub-section of bonds now account for 17% of the broader climate bond market, an increase from 11% the previous year.INSTITUTIONS DRIVE DEMAND “Most of the demand is coming from institutions who by nature have a long-term time horizon and are exposed to the consequences of climate change,” says Bram Bos, lead portfolio manager for NN IP’s Euro Green Bond fund. He points to the risk of exposure to stranded assets (such as oil reserves that will no longer be exploitable as regulations tighten) or higher insurance claims resulting from flooding. Institutions have started taking climate change much more seriously over the last two years as the dialogue around the issue changed in focus away from ethics towards risk management with high-profile commentators, including the Bank of England governor, Mark Carney, suggesting asset owners were in breach of their fiduciary duty if they failed to account for the risks associated with climate change. Peer pressure has also mounted as more institutional investors have signed up to initiatives such as the Portfolio Decarbonisation Coalition. Meanwhile, regulators are also increasing the pressure through agreements such as COP21 and are becoming increasingly aware of the powerful force asset owners can play in financing and policing the the corporate sector. Financial innovations, including green bonds and low-carbon indices, have also made the historically challenging task of green investment considerably easier. Some of the world’s heavy-weight institutions have already allocated significant assets to these innovations, including CalSTRS, the New York State Common Retirement Fund, Sweden’s AP2, France’s Fonds de Réserve pour les Retraites (FRR) and the United Nations Joint Staff Pension Fund. Lombard Odier’s Bertrand Gacon, head of impact investing and SRI, says green bonds should be a “no brainer” for institutions. “Green bonds allow institutions to invest in green projects without compromising on their fiduciary duty to provide long-term returns and risk management processes,” he says.