Green bonds, while often considered environmentally friendly investments, do not always adhere to their eco-friendly label.
In the rapidly growing market for green bonds, it is essential for investors to carefully assess the credibility and environmental impact of these financial instruments. Here are some best practices to guide your evaluation process.
- Independent Third-Party Reviews and Certification
Green bonds should ideally undergo an independent external review or second-party opinion that assesses alignment with recognised standards, such as the Green Bond Principles (GBP) by the International Capital Market Association (ICMA). Certification against an external green standard or label by accredited third parties ensures that the bond's Use of Proceeds meets stringent environmental criteria, thereby enhancing credibility.
- Transparency and Reporting
Transparency in the allocation of proceeds and regular public reporting on environmental impact are essential. Issuers should provide clear, detailed statements on how funds are used and the positive environmental outcomes generated, aligned with frameworks like the GBP. This includes third-party verification or assurance of environmental impact reporting.
- Use of Established Evaluation Frameworks or Ratings
Employing specialized green bond scoring or rating agencies enhances evaluation. These agencies assess environmental performance data, procedural adherence to green bond guidelines, and compatibility with climate scenarios (e.g., 2-degree warming targets). Such ratings help investors gauge not just credit risk but also sustainability risk and impact.
- Adoption of Flexible, Yet Robust, Principles
Voluntary but robust principles, such as those developed by ICMA, serve as a market consensus foundation. They provide flexibility for regional or sector-specific adaptation while maintaining a firm emphasis on transparency and environmental integrity.
- Post-Issuance Monitoring and Impact Assessment
Assessing the bond over time for actual environmental performance is critical. This involves monitoring use of proceeds, continued adherence to green criteria, and positive environmental outcomes such as reductions in carbon emissions. This ongoing evaluation helps validate the initial credibility and environmental claims, protecting against "greenwashing."
- Consideration of Market and Company Specific Factors
Green bond evaluation should consider the issuer’s overall environmental strategy and governance. Research shows that certification adds significant credibility, as only certified green bonds tend to show meaningful positive market and environmental performance. Matching issuers with peer companies helps isolate the green bond’s real effect separate from broader corporate sustainability practices.
In summary, best practices for evaluating green bonds revolve around independent verification and certification, transparency in reporting, use of credible scoring or rating systems, adherence to widely accepted principles, and ongoing impact monitoring. These measures together ensure the green bond's credibility and demonstrate its positive environmental contribution, enabling informed decision-making by investors and other stakeholders.
It is worth noting that the overall impact assessment combines the evaluation of credibility and additional benefit. As the European Union plans to emit green bonds worth €225 billion as part of its COVID-19 recovery package, these best practices will be increasingly important for ensuring that these funds are used effectively and sustainably. However, it is also crucial to remain vigilant, as high-profile cases have shown that issuers of green bonds have not always fulfilled the stated purpose of the collected capital. The ratings facilitate interaction with issuers, provide feedback, and convey information to ESG-oriented investors.
- Investing in Green Bonds with Certification: Certification against external green standards or labels by accredited third parties reinforces the credibility of green bonds and assures investors that the Use of Proceeds meets stringent environmental criteria.
- Assessing the Environmental Performance of Green Bonds: Post-issuance monitoring and impact assessment are vital for evaluating the actual environmental performance of green bonds, including the use of proceeds, adherence to green criteria, and reductions in carbon emissions over time.
- Incorporating Additional Factors in Green Bond Evaluation: Green bond evaluation should also consider the issuer's overall environmental strategy and governance, as research shows that certified green bonds tend to show meaningful positive market and environmental performance in comparison with their non-certified counterparts.
