Amid predictions that the 30-year bull market in bonds may be coming to an end, there is a segment of the fixed income market that is still enjoying strong support - the so-called ‘green bond’ market.
Green bonds provide the financing for projects that aim to deliver positive environmental outcomes and/or climate benefits. As the global push towards 'socially responsible investing' has gathered steam, so has the size of the green bond market. Moody's expects the gross issuance of green bonds to exceed US$200 billion in 2017, double the amount issued in 2016. Since Australian dollar-denominated green bonds were first issued in 2013, more than A$3 billion has been issued by sovereign and supranational entities, state governments, domestic banks and corporates.
A bona fide green bond issue is certified externally by a certifier, such as the Climate Bonds Initiative, at a cost for both initial and on-going certification. These certification costs are currently not being passed on to end investors, as green bonds have been issued at “fair value” compared to existing non-green bonds. In theory, failing to pass on these costs could lead to sub-optimal financing of green projects. However, one could argue that the green bond market has opened up new pools of investors, whose mandate to invest in ‘green’ strategies makes ownership of these bonds more stable and as a result, green bonds may be less likely to weaken compared with the issuer’s non-green bonds in adverse markets. This argument has some merit and Aberdeen has supported select green bonds issued into the Australian bond market.
For established issuers, such as KfW and IBRD, the financing of environmental and social projects is in their DNA, and they have been doing it for a long time. They are natural candidates for formalising the arrangement and issuing green bonds to green investors.
On the other hand, certain issuers are simply not that green.
On the other hand, certain issuers are simply not that green. Some Australian state governments for example, have jumped on the bandwagon in recent months and, in Aberdeen’s opinion, their projects are a much lighter shade of green.
For example, Victoria issued a relatively small line of green bonds in July 2016 and aims to grow the amount of green bonds on issuance to match approximately A$2 billion of Victorian green projects, certified in accordance with the Climate Bond Standard v2.1. A closer look at the eligible projects, however, shows that more than 75% of the notional value of these projects is related to the build-out of electrified rail networks. These networks are themselves powered mostly by coal-fired power stations. Even after the imminent removal of capacity from the Hazelwood Power Station, coal will still generate more than half of Victoria’s electricity. ‘Brown bonds’ doesn’t sound quite as catchy.
According to the Climate Bonds Initiative, all infrastructure, infrastructure upgrades, rolling stock and vehicles for electrified public transport pass the ‘Low Carbon Transport’ criterion and therefore get the “green” blessing. However, we would argue that brown-coal powered electric rail development is not in the same green league as wind power, solar power or biomass projects.
While we might question its green credentials, we’re not completely against brown coal-powered electricity – the residents of South Australia would have more than happy for some cheap, reliable base-load energy over the last few months! Similarly, Queensland issued A$750 million of green bonds in March. The pool of projects here is even more skewed to low-carbon transport, with around 90% of the projects related to rail infrastructure build-out. The same underlying challenge is present, as 65% of the State’s electricity requirements are generated by burning coal – more in fact than Victoria’s.
The World Bank predicts that transport-related CO2 emissions in OECD countries will rise 17% by 2050 – which is significant, although far less than the threefold increase in emissions predicted from emerging market economies, which issuers such as IBRD are looking to address. While we agree that every bit helps - including the development of low-carbon transport in a developed country such as Australia – we do question whether or not this justifies the additional costs of certification and marketing of this new product? Particularly, as outlined above, when the end investor is not paying for these additional costs? Victoria budgeted for approximately A$17 billion of ‘transport & communications’ capital investment over its budget period – about two-thirds of overall investment – before launching its debut green bond. In other words, it was already planning to invest in electrified public transport, as it has done for years, prior to receiving ‘green’ funding. Considering that Australia’s energy production (including those brown coal-fired power stations) emits more than twice the CO2 emissions than transport, we’d be less cynical if more of these funds were being devoted towards rectifying emissions in that sector.
At Aberdeen, we can’t help but see these recent issues as a somewhat cynical exercise in marketing, trading on the buzz themes of the day. We have therefore avoided investing in the recent state government green bonds and will continue to scrutinise the project quality of upcoming green bonds.
In a bond universe with many shades of brown and green, Aberdeen prefers to operate in the “true to label” green spectrum.
This article originally appeared in Investor Daily on 2 May 2017.