Bond investors at risk of becoming victims of greenwashing/mis-labelled green bonds

Investors need to be savvier than ever to avoid greenwashing as the market for green bonds reaches new heights, says James Rich, Senior Portfolio Manager at Aegon Asset Management.

Demand for green bonds has soared in the past few years, with global issuance rocketing six-fold from just USD38 billion in 2015 to USD226 billion last year. In the third-quarter last year, issuance hit a record USD85 billion, representing 69% growth year-on-year, according to Bloomberg.
 
While surging issuance means more choice for investors, it also means they have to be more discerning to avoid greenwashing, says Rich. “Issuance of green, social, and sustainability bonds, so-called ‘labelled’ bonds, surged in 2020 as companies rushed to fund sustainability initiatives, and we expect this growth to continue into 2021,” he said.
 
“However, many first-time labelled bond issuers are opportunistically issuing to take advantage of lower interest rates relative to plain vanilla financing. As a result, the risk of greenwashing through labelled bonds is growing, indicating a need for investors to carefully assess each issuance on a case-by-case basis.
 
“In the absence of a common industry standard, issuers of labelled bonds can be prone to false promises. Many companies fail to publish promised reports on their labelled bonds or inadequately report on the metrics that are most relevant to measure the success of the identified projects.”
 
With a lack of industry-wide standards on such bonds, Rich believes it is essential to thoroughly assess each labelled bond issuance on a case-by-case basis across five key areas.
 
1. Use of proceeds - study the alignment of the bond’s use of proceeds with stated projects.
 
“First and foremost, it is important to ensure that the offering documents outline the projects and the intended money allocation.
 
“A detailed review of the documents can help ensure the alignment of use of proceeds with sustainable themes. For example, we measure the green bond’s use of proceeds against relevant sustainable themes.”
 
2. Governance - evaluate the company's internal governance framework around the use of proceeds.
 
“We ensure that the corporate governance surrounding the use of proceeds is robust. An evaluation of corporate governance can help investors understand how the company thinks about this green bond and evaluate their commitment to sustainability.
 
3. Frameworks - consider the use of green bond frameworks, such as Green Bond Principles by ICMA.
 
“We evaluate if the issuance is supportive or aligned with a particular framework such as ICMA Green Bond Principles, which could help us verify if the issuance is aligned with a particular green investment criterion.
 
“Despite the criticism towards frameworks, labelled bonds are transaction-level decisions, in which frameworks can still bring value in terms of seeking standardisation. The use of standards often brings third-party verification which can bring some assurances of the overall labelled issuance program.
 
4. Reporting - assess the green bond reporting framework.
 
“Post-issuance reporting is fundamental to verify the impacts of the issuance proceeds on eligible projects listed at the outset of green bond issuance.
 
“The most robust issuance clearly outlines that the proceeds are allocated and includes relevant metrics to measure to success of each project. However, since reporting is not enforced, often companies will not follow through on reporting after issuance. In those situations, we engage with companies to encourage sufficient reporting.”
 
5. Alignment - determine whether the issuance is a one-off or part of a long-term strategy to improve the sustainability of the business.
 
“This key step can help focus on the issuer’s broader approach to long-term sustainability.
 
“Is the issuer capitalising on the investor demand of labelled bonds today with no intention of building towards long-term sustainability or making credible steps towards a more sustainable future?”
 
Beyond green bonds, Rich and the team at Aegon AM are finding many opportunities to invest sustainably. 
 
“Labelled bonds can be an attractive sustainable investment when the use of proceeds is fully aligned and transparent. However, there are numerous issuers with products, services and business practices that address sustainability issues that do not issue labelled bonds,” Rich explained.
 
“By identifying issuers with products, services or practices that align with sustainability initiatives, investors can identify numerous opportunities to invest sustainably while pursuing competitive excess returns over the long term.”

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