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Investing

Green bonds need definitions and standards first

Kate Hollis said investors need to know what they’re getting into before starting a green bond program.

While some institutional investors are buying green bonds, sources said work is still needed around standards, wording and definitions before green bond investment becomes mainstream.

"We are getting a lot of questions, but seeing very little actual interest," said Kate Hollis, senior investment consultant in London at Willis Towers Watson PLC. "There are a couple of reasons. First, before you fund a green bond mandate you should ... define your beliefs around sustainability — a lot of clients are working on that." Ms. Hollis said investors "need to be clear about why they are investing in green bonds and what they expect to achieve."

Another issue is "the definition of what makes a bond green is peculiarly unclear." While a lot of work has been done on sustainable equities, work on the credit side has been lacking, she said.

The International Capital Market Association, a membership organization for financial sector firms, formulated four principles on green bonds, but these are not legally binding noted Danish pension fund ATP, Hilleroed, in its 2017 Sustainability Report.

"The question of taxonomy is a huge one, and of course the whole term 'green bond' is based on the voluntary ICMA Green Bond Principles," said Monica Insoll, managing director and head of the credit market research team at Fitch Ratings Inc. in London. "It is very much up for grabs in terms of how anyone is defining it ... From an asset manager's perspective we think (assessing the greenness) is quite cumbersome, but we understand that many asset managers will buy a green bond based on if they know the issuer from holding other bonds. There is a debate on whether to tighten up (the definition). Fitch's rating criteria accounts for environmental, social and governance factors in a number of key areas and is explicit when they are key ratings drivers impacting the cash flows of issuers."

But work is being done. A European Commission-appointed High Level Expert Group examining sustainable finance in Europe said in its final report in January that official European sustainability standards for certain financial assets — beginning with green bonds — should be developed.

"We are encouraged by this and believe that progress in this area is likely to lead to a stronger and more transparent framework for sustainable investment opportunities," said Joshua Kendall, ESG analyst at Insight Investment in London.

While issuing a green bond follows no strict definition, "there is an increasing number of country-level and regional guidelines, for example the European Investment Bank and China Green Finance Committee are looking to harmonize the definitions for green investments between the EU and China," said Dominik Poiger, portfolio manager at Van Eck in Frankfurt. "Further harmonization could strengthen the label 'green bond' and help attract investors or develop investment solutions that target exclusively green investments."

But for some money managers, a lack of standards is an opportunity "because we can use our sustainability expertise to define and filter those green bonds that make sense from a long-term perspective," said Felipe Gordillo, senior ESG analyst at BNP Paribas Asset Management in Paris. However, he added: "One of the most interesting things we are seeing at this moment, specifically here in Europe, is that policymakers are starting to pay attention to the development of this market. One of the main topics within the report provided by the (High Level Expert Group) was on the topic of green bonds. One of the main propositions was to say here in Europe, the EC may want to work in the elaboration of a European green bonds standard. That will create a formal framework to issue green bonds in the European space."

Some issuers give investors exactly what they expect. The World Bank, which issued the first labelled green bond in 2008, "is unique in that the entire mandate for us is to promote sustainable development," said Heike Reichelt, head of investor relations and new product development in Washington. "So, every single project that we finance is designed based on the social impact it aims to achieve."

The organization is engaging with institutional investors on the United Nations Sustainable Development Goals — designed to work toward a sustainable future. The World Bank offers triple-A rated, liquid investment opportunities. Pension funds that already take an ESG approach to their equity portfolios often go to the organization as they search for ways to integrate sustainability into their fixed-income portfolios, she added. In that case, labeled bonds are a potential starting point, "because those are focused on transparency around the purpose of the investment and impact."

Some institutions already know what they want. A spokeswoman for the $231.6 billion California State Teachers' Retirement System, West Sacramento, said: "First and foremost, the bond must provide relative value and meet our credit standards. Then we would like the issuer to follow the (ICMA) Green Bond Principles or be certified by the Climate Bonds Initiative," an international not-for-profit organization.

It is "great" if an issued bond is by a familiar issuer so executives can focus on the green component of the bond, the statement continued, and "we prefer a roadshow on first-time issuers with adequate time for analysis. We would love roadshows every time, but that does not seem reasonable for repeat issuers. We prefer index-eligible bonds, though we can and have bought non-index eligible bonds."