The Green Bonds Revolution: Is the grass actually greener on the other side?

Is the Green Bond Market Really Green? Join Ravi Chidambaram in a candid conversation with green finance expert Alexandra Tracy as they delve deep into the world of green bonds. Is it truly a game-changer for sustainability, or just another marketing gimmick? Uncover the challenges, opportunities, and potential impact of the green finance market as they separate fact from fiction in this episode of Debunking ESG Myths.

Discussion Topics: The Green Bonds Revolution

• What is green finance?
• Evolution of the market in Asia
• Market skepticism around green bonds
• What are some advisable reforms to get rid of skepticism?
• What is a more serious way to start doing green bonds in a corporation?
• What is the role of rating agencies?
• Role of banks to fill the gap
• What is the purpose of the green bond market?

Transcript: The Green Bonds Revolution

Ravi Chidambaram: Welcome to ESG Mythbusters, a podcast where we debunk, demystify, and deconstruct some key ESG preconceptions with unfiltered knowledge and data from key experts in the field. I’m Ravi Chidambaram, CEO and founder of RIMM Sustainability, an impact-driven SaaS company that advocates making sustainability accessible and actionable to all. In this episode, we’re really excited to welcome Alexandra Tracy, a key thought leader and expert in the green finance industry, who’s played a very large part in driving strategies and policies around sustainable finance. She’s currently based in Hong Kong and is especially familiar with the development of this space in Asia. Alexandra, it’s great to have you.

Alexandra Tracy: Thank you very much for having me.

Ravi Chidambaram: Great, well, let’s just jump right to it then. I’m sure our audience would love to hear more about the entire green finance market as it’s highly relevant, highly topical, and a lot in the news. But maybe we could start by clarifying what green finance really is.

What is green finance?

Alexandra Tracy: Green finance is, it’s really a very broad term that’s now used to capture supplying capital, could be investment, could be lending to fund activities that have a positive environmental impact. It’s not only about green bonds, but they do seem to take up a lot of the attention.

And the green bond world has been rapidly evolving and becoming quite confusing. So now we talk about green bonds, social bonds, and sustainability bonds, which are both green and social or GSS bonds for short. These three categories are also called labeled bonds, where the use of proceeds has to be predefined and allocated to a very strict set of green or social projects.

Then there’s another category which is called sustainability-linked bonds, or loans. These are very new in Asia. And here the proceeds can be used for whatever the issuer wants to use them for. However, the interest rate is linked to pre-agreed targets. So if the company meets them, the pricing is cheaper.

If it misses them, there’s a penalty. And they tend to be around reducing emissions, diversity, biodiversity, that kind of thing.

Ravi Chidambaram: Okay, well, thank you for that initial explanation.

But if we stay with the green bond theme, Alexandra you’ve been very involved in Asia in terms of the development of that capital market. Could you tell us a bit about the evolution of the market in Asia, the role it’s playing overall in the global development of green bonds, and why some unique macroeconomic climate and environmental factors are kind of driving that growth, particularly in the Asian context?

Evolution of the market in Asia

Alexandra Tracy: Asia is still a relatively small portion of the overall green bond market. About two-thirds of the issuance is still coming out of Europe. But we now make up about a quarter of the total. And in 2022, about $115 billion worth of green bonds were issued in the region. We see that China tends to dominate.

There are some very good quality issuers out of North Asia and increasingly now in Southeast Asia. This year Singapore issued its first sovereign green bond. The Philippines issued its first sovereign sustainability bond. We’re seeing more local currency bonds, which is very important because it means that local investors are actually buying them.

And in fact, last month, we saw the very first green bond coming out of Cambodia. So there’s enormous diversity now. But what that means is that there is also a certain degree of challenge because standards are not yet consistent across the region.

There’s a lot of work to put together taxonomies and standards for green bonds, but different countries are still developing their own. They overlap. They tend to be based on what’s called the green bond principles that were put together by the International Capital Markets Association. But they do have local variations.

And so I think it’s very important that investors do their own due diligence. You can’t just say this is a labelled green bond and then think no more about it. You really do have to understand what the company’s history with sustainability is and what it’s likely to be committed to going forward.

Ravi Chidambaram: Do you think that green bonds will play an even bigger role in Asia going forward?

Alexandra Tracy: I think there is enormous demand for green bonds in Asia. A lot of institutional investors like pension funds have specific mandates to buy ESG or green paper. And so they’re looking for quality issuance. And in fact, we’re now also seeing growing demand coming from retail. High net worth investor market.

There was a survey last year that found that about a third of the affluent sector in Asia was already investing according to ESG principles, and about another third said that they would do so this year. So there’s a lot of pent-up demand, and at the moment the challenge actually is to create those quality investments across the region, to put that money to work.

Ravi Chidambaram: Yep. Despite the hype around green bonds, I also noticed that there’s a fair amount of market scepticism, as there tends to be in any new and evolving asset class. So in the case of green bonds, I did a bit of research and checked the spreads in the secondary market between green bonds and conventional bonds.

And found that those spreads are actually very narrow, which suggests that investors are not really differentiating green bonds as something that is a financial asset class, as well as perhaps the impact it may be having in terms of sustainability. So let’s unpack, some of the elements of the market scepticism around green bonds.

Market scepticism around green bonds

Ravi Chidambaram: Yeah. Well, the issue right now is that the market is, in fact, largely unregulated. It’s really on a voluntary basis. So issuers can self-label a bond as green with no outside verification. And clearly, that means that there’s gonna be a lack of consistency, and there may be a lack of quality.

Alexandra Tracy:  There are no standard definitions around project criteria verification. Now ICMA, which writes the Green Bond Principles, does recommend that for both pre and post-issuance, there should be a third-party review. But this is still voluntary and in fact, the way that this third-party review is done also varies very widely. You have a second-party opinion as to which ESG consultants have a nice business in providing there’s also verification and assurance which the accounting companies tend to do Certification there are some government programs.

And then also the rating agencies are in the game. So the methodologies are all different, and they’re voluntary anyway.

So, as I say, investors really do need to do their own due diligence, and not rely blindly on these things. One of the things I think that we need to take into account very much with label green bonds is that sometimes the use of proceeds may be allocated very strictly to green projects, but it completely ignores the rest of the company’s business.

And so then you may have a weird anomalous situation where A utility issues a green bond to finance a renewable energy project and then they take the profits from that project and use them to build a coal-fired power plant, let’s say. So where does that leave you with your green bond? People are still trying to find their way through.

A lot of investors won’t touch bank paper for that reason, because the bank’s raising new green capital. But they have a big legacy portfolio in fossil fuels. And I mean, just one more example is up here. The Hong Kong Airport authority issued a green bond a few years ago, which was quite controversial because The proceeds of the bond were not supporting the third runway, which is currently under construction.

They were supporting all the ancillary infrastructure. And so you could argue that was a very controversial way to structure the financing.

Ravi Chidambaram: And I think that really comes on then to the second aspect of the market scepticism around green bonds in that it’s self-evident that green bonds should be green because they are creating positive environmental or social impact.

As you pointed out, even on a project level, the monitoring and disclosure around impact and milestones achieved I think are patchy at best. And then certainly you make a great point that if an issuer fundamentally has an unsustainable business model, but they’re issuing green bonds around ring fence green projects, then that creates a bit of a moral dilemma in the eyes of the market.

Alexandra Tracy: I think it just causes confusion. And then if you look at it from the other side there are a lot of companies out there who are Genuinely green in everything that they do, whether they’re a renewable energy company or a railway green transportation project and they will issue bonds just off the back of their own credit.

And in the market, these get called unlabeled green bonds, because in fact, the proceeds are absolutely attributable, but they’re not going through that labelling process.

Ravi Chidambaram: What are some of the reforms you would suggest in order to kind of help do away with this market scepticism, I mean, what would there be reforms in the way prospectuses are issued the way disclosures are monitored should it be linked to certain targets where if they’re not met?

What are some advisable reforms to get rid of scepticism?

Alexandra Tracy: I think there are a number of areas. First of all, we definitely need to see more convergence between the standards. And that’s common across the sort of green finance and ESG world we’ve had this alphabet soup. It’s been very challenging. And now I think some of those regulatory regimes are coming together.

So we’re also seeing that here and the promulgation of the ASEAN green taxonomy is very positive because that covers a much wider region. And I think most of the companies in the individual countries are quite consistent with it. One of the other very positive developments has been what they call the common ground taxonomy which is jargon for a convergence of standards between China and the EU on green bonds.

So that has an enormous impact. I think the next area is to think about moving from voluntary to mandatory and, particularly in the area of third-party verifications, the pre and post-reporting. At the moment on the post reporting there’s tremendous flexibility on how you do it.

Some companies produce a very detailed report on the use of proceeds and the management of proceeds. And other companies just give you a little bit of information on their website. And both of these are considered acceptable at the moment. The other thing that I think very few people know is that typically green bond documentation does not include covenants that legally require an issuer to use the proceeds for the green commitments that they have made.

And if they fail to do this, there’s not an event of default under the documentation. So I think that’s something else that we could certainly have a look at.

Ravi Chidambaram: Well, I mean, that’s a tremendous loophole really which is quite shocking, right? But then if this is the case currently, then why do investors buy the green bonds, would you argue they’re buying them really purely on a commercial basis? 

Alexandra Tracy: Rather than with the impact in mind, I think that a lot of investors, clearly look at the credit rating of the company. Most of the issues are changing slightly, but most of the issues have been Sovereign, quasi-sovereign development banks, multilateral, obviously, very strong credit, and they, I think, are very genuine, that they wish to have a, an impact, a policy impact, and for investors, there’s, there’s absolutely no downside in buying that paper, even if you may be giving up a tiny piece of the yield.

Where I think it becomes more interesting is when a wider range of corporations start issuing. We need to move beyond this sort of highly rated company issues bond because I think as you say that is not moving the market very much. And the potential power of these instruments is to mobilise capital into areas that would otherwise struggle to raise funding.

And so we’re seeing some very interesting things now. Some subsets of green bonds, some spinoffs for example, what they call blue bonds, which fund ocean conservation, and biodiversity bonds. Even climate resilience bonds, the climate bonds initiative, and a part of the UN are working on standards for this.

And this will be very interesting to help, I think, governments and municipalities to raise money for climate adaptation, which is clearly a key topic going forward. So I think that there’s a lot of evolution and innovation coming into the market now. It’s still very nascent. But I hope we’ll see a lot more capital going in these directions right?

Ravi Chidambaram: So speaking of corporate issuance, I noticed there was a very interesting recent issuance by Schneider Electric, generally considered to be one of the more sustainable companies in the world they did target ESG targets, linked convertible bonds. Where they set some very specific E and S targets for the company to meet, have third parties audit those targets, and have the pricing linked to meeting those targets. Is that a more serious way of going about doing green bonds in the corporate sector?

What is a more serious way to start doing green bonds in a corporation?

Alexandra Tracy: I think we’re seeing a lot more of these sustainability-linked target-linked issuances. As I say, very few in Asia so far, but it’s going to be extremely important to support the hard-to-abate sectors and to support the transition. I think what’s important is to make sure that the targets get set at the right level.

Sometimes there’s been criticism that targets are not ambitious enough or that some companies can gain them slightly. And so for example, there have been occasions where companies have been criticised for having a KPI, which is emissions reduction, which they can meet, but they meet it by excluding scope three emissions, for example.

And so these are kind of the loopholes that need to be filled. I mean, the other facet of these kinds of instruments is that actually very often they’ll have a call option, which means that if targets are looking extremely dodgy, they can actually buy back or cancel the debt.

And so again, that’s a bit of jiggery pokery that needs to be ironed out, I think, as the market develops.

Ravi Chidambaram: What about the role of rating agencies? I noticed that S & P recently abandoned ratings, numerical ratings for green bonds, and Sustainalytics, who I think are the major players in green bond ratings, have also come under some scrutiny for the ratings. How does the ratings game play out in the green bond space?

What is the role of rating agencies?

Alexandra Tracy: I mean, the rating agencies are just only one of the one of the players involved in this. As I mentioned some green bonds will be rated by S& P or Moody. Other green bonds, as you say, will be verified by Sustainalytics Cicero or other companies. And they do have different methodologies and they’re not consistent and there’s still a certain amount of a black box element to it.

One of the issues in Asia, of course, is around the difficulty of gathering ESG data, as well. And that means that sometimes it tends to be very backward-looking, where what you want is forward-looking data. But that is very challenging to put together. So I think some of these companies are a little bit wary because…

They’ve faced criticism. I mean, I mentioned the Hong Kong airport deal. That was verified and had a third-party certification from Sustainalytics. And yet they faced a lot of criticism. So I think some of them are now looking a little bit carefully at how they do this going forward.

Ravi Chidambaram: So, I want to talk broadly about this whole green bond label in the context of the green bond market and, kind of where we need to go with the green bond label for it to have credibility, For it to serve its purpose of raising issuance volume and creating impact.

Alexandra Tracy: I think as I say we’re seeing an evolution already. And really the Interesting opportunity here is to allocate capital into new sectors. Right now there’s quite a lot of concentration risk. You find that most of the corporations that issue green bonds are utilities or property companies.

And therefore investors may, they may be looking for more diversity. There also actually tends to be some liquidity risk, especially where there are smaller corporate issuers. And you’ll find that the institutions who want to buy the bonds tend to hold them to maturity. So there isn’t actually that much trading in some cases, and that has an impact on the market as well.

So I think that the more diversity that can be encouraged will be very important. But some of these newer issuers, I think, really need help to sort of navigate the Green Bond maze and work out whether it’s the best strategy for them.

Ravi Chidambaram: What about the role of banks? Banks have been criticised for being very slow on the green lending side, particularly to SMEs, right? And they could play an important role in filling gaps in the market.

but yet I’ve heard complaints quite often that, if they go to a bank and they have genuine sustainability targets, they want to meet. They often get, loans of small amounts that are only 5 or 10 basis points cheaper than a conventional loan. So, it seems to me that banks also Have an important bridge role to play in the private capital markets for green debt, but are not doing so today around Asia.

Role of banks to fill the gap

Alexandra Tracy: We talk about the capital markets, we talk about green bonds, but actually the vast bulk of capital that is being allocated in Asia is coming out of commercial banks. So it’s extremely important that they get on board and support the transition.

And I think it’s a matter of market education. At the moment there is a lack of expertise, especially in the lesser developed markets. I think there’s a lack of understanding of how to structure these kinds of transactions, exactly what kind of targets are appropriate, how to monitor them, and what reporting they should be asking for from the companies.

And so that’s an evolution that still needs to happen. At the moment, I think sustainability is linked. Loans across the region are something like 9 percent of the global total. So there, there’s a huge potential upside there.

Ravi Chidambaram: Do you think that we talked about regulatory reforms on bond issuance itself and capital markets regulations, but what about financial regulations where the banking regulators in the country actually start setting targets for banks on green loan allocations?

Alexandra Tracy: I think that’s coming. I know that the regulators in a number of countries are already looking at that. I mean, certainly, Hong Kong has spent a lot of time and Singapore is there. So that is definitely the next chapter.

One of the other tools that central banks can use is around provisioning regulations where there can be more flexibility depending on whether a loan is considered to be green or not. And that’s a very strong incentive for a local bank to consider that kind of transaction.

Ravi Chidambaram: Yeah. That’s a very good point. The key thing that I wanted to ask you about is ultimately what do you see as the purpose of the green bond market, the green loan market?

Do you want to see fundamental behavioural change and social and environmental outcomes? That is achieved with that and ultimately you would judge the market a failure, even if issuance volume went up 10 times, even if green loans became a bigger thing, how would you ultimately judge the success of this market?

What is the purpose of the green bond market?

Alexandra Tracy: I want to see this market being used to mobilise additional capital that is not currently flowing. There, there is no enormous change to the world if highly rated issuers issue green bonds along much, The same terms the same credit rating, and the same provisions that they would otherwise.

It’s not a bad thing, it’s a nice thing that they do, but it is at least partly a marketing exercise. What I want to see is capital flowing to different areas to support greenfield projects, for example, that struggle to raise funds. And particularly, I would like to see the development of an asset-backed market in Asia, where you can pull together green assets that currently sit on banks balance sheets issue fixed-income securities off the back of them, and then free up that capital so that the banks, as we said, who play such an important role, can support new green projects.

Yeah, no, that’s strong stuff, Alexandra. And on that note, let me wrap up. Maybe I can summarise Alexandra’s points. Basically, the green bond market hot topic issues in Asia is an important part of it. But clearly, the market is in its very nascent stages and needs a lot of reform. It needs reform across the value chain.

Ravi Chidambaram: With different capital markets, and actors probably being more regulated in the way prospectuses are issued, banks basically bring these issues to market, how rating agencies go about rating them, and how investors view them. Banks also have an important role to play, but again, probably needed.

More supervision and regulation from regulators to make the green loan markets work better. And clearly, it’s a young market in that it’s very heterogeneous. The definition of green can vary. It’s not linked to monitoring and targets. And sadly, and the most important point of all, I think that Alexandra has made is that it’s a case of the rich getting richer at the moment in that those who have the most ready-made access to the markets with high ratings.

Are simply sort of adding another instrument, to their credit portfolio by issuing bonds and those who really need it. IE project-based projects, asset-based projects, and so on, aren’t simply not getting access to that capital today. And that is such a shortcoming and failure of the market today. And this is where we will really begin to see an impact. Do you have anything to add in closing Alexandra?

Alexandra Tracy: I’d just like to say not to be too cynical that there is investor appetite for green bonds.

Ravi Chidambaram: No, we want you to be cynical and honest. That’s why it’s ESG Mythbusters.

Alexandra Tracy: Alright. we need to move forward and, there needs to be more diversification and and less focus I think on some of the things that we’ve seen so far. But for the company side, there is some value in considering a green bond. Because it prompts you to do the analysis on your own business.

to think about setting up a Green Bond Framework, which then allows you to issue a bunch of securities. You don’t just do it once. You can have a program over time. And really just analysing whether this works for you or not. And I think clearly this is where RIMM can come in and help and try to demystify the standards and improve transparency.

And that, in itself I think is quite important.

Ravi Chidambaram: That’s a very good thought. Yes. Thank you very much for being on the show today, Alexandra. Thank you to our audience for joining us and busting some other ESG myths with us today. We hope you’ve gained some key insights and found new perspectives. Again, thanks to our esteemed guest, Alexandra, for providing, some honest and insightful views on the green bond and green loan market.

We’ll see you guys in two weeks to bust our next myth. Keep listening and please share with your friends. Thank you very much.

Alexandra Tracy: Thank you.

Our Guest: Alexandra Tracy

Alexandra Boakes Tracy has been in the investment banking space for over 20 years and has transitioned through private equity and a number of start-up businesses. She is currently the President of Hoi Ping Ventures in Hong Kong and also provides research and consulting on investment in low-carbon energy and infrastructure in Asian emerging markets. She is a key thought leader and expert in the green finance industry and has played a very large part in driving strategies and policies around sustainable finance.