Once occupying a tiny fraction of global financial markets, “green bonds” have grown exponentially in the past decade to become one of the world’s fastest-growing asset classes.
In February 2024, Bloomberg reported that total impact bond issuance — a catch-all word to include green, social, sustainability, and sustainability-linked bonds, but more on these later — totalled US$939 billion in 2023, a 3% increase from the same period last year. While 2023 is not the highest year on record, it is a record year for green bond sales from corporates and governments, which reached $575 billion for the first time in history. The highest was in 2021, when copy.1 trillion was issued.
To the inexperienced, all these bonds may look and sound the same. In fact, there are some variances.
“Sustainability Bonds” denote any type of bond instrument where the proceeds or net proceeds will be exclusively used to finance or re-finance a combination of projects that boast clear environmental benefits (“green”) or mitigating some specific social problem or create social benefits (“social”).
“Green bonds” and “social bonds” refer to any type of bond instruments where the proceeds or net proceeds will be exclusively used to finance either green projects (for green bonds) or social projects (for social bonds).
Typical green projects for which funds are raised via “green bonds” include renewable energy, energy efficiency, pollution prevention and control, environmentally sustainable management of land use, biodiversity conservation, clean transportation, sustainable water and wastewater management, climate change adaptation, circular economy, and green buildings.
Under this terminology, “climate bonds” are therefore a subcategory — it refers to any “green bonds” whose proceeds or net proceeds are raised for climate mitigation or climate adaptation projects.
Typical social benefit projects for which funds are raised via “social bonds” include affordable housing, food security, access to essential services, and socioeconomic empowerment for vulnerable groups.
An interesting category of impact bonds is “Sustainability-Linked Bonds”. According to the 2024 Guidance Handbook issued by the International Capital Market Association (ICMA), owner of the de facto global sustainable bond standard since its green/social bond standards are referenced by 97% of all issuers worldwide, Sustainability-Linked Bonds “are any type of bond instrument for which the financial and/or structural characteristics (eg coupon, maturity, repayment amount) can vary depending on whether the issuer achieves predefined sustainability/environmental and/or social and/or governance (ESG) objectives within a predefined timeline, and which are aligned with the core components on the [Sustainability-Linked Bond Principles or the] SLBP.”
Thailand jumped on the sustainable/green bond bandwagon early. The first green bond in Thailand was issued by TMB Bank (now TMBThanachart Bank) in June 2018. Two years later, the Thai government launched Asean’s first sustainability bond in August 2020. The proceeds were earmarked to support Covid-19 relief packages and fund a project on the MRT’s Orange Line.
Thailand’s Securities and Exchange Commission (SEC) translated various ICMA guidelines between 2018-2021 and issued a guideline that the green/social/sustainable bond issuer is free to reference internationally accepted standards, including Asean Green Bond Standards, ICMA principles/guidelines, and/or Thailand Taxonomy.
Overall, private companies and government in Thailand issued copy2.2 billion impact bonds between 2018-2022, the second highest in Asean behind Singapore, according to data collected by Thai Bond Market Association.
Even so, the rapid growth and high promise of green bonds are now fraught with many daunting challenges. There is yet no single accepted global standard or a commonly recognised legal framework, and the entire green bond market globally is based on voluntary compliance. Therefore, it is difficult for investors to determine if the bonds are green or not, or as green as the issuer claims.
Elements that are common across many green bond standards, including the ICMA’s Green Bond Principles, include: use of proceeds disclosure that specifies exactly which green projects the proceeds will finance, ongoing reporting on the stated used of proceeds, and the provision of a second opinion by an independent third party. However, none of these important elements gives any actionable rights to the bondholders. For example, many bonds state in the prospectus that even if the issuer fails to apply the use of proceeds for eligible green projects, this event will not constitute an event of default.
The fact that all the green bond’s important elements are not tied to actionable rights of bondholders was perhaps necessary in the early days when green bonds were new, some investors were perhaps willing to forego strict covenants to encourage issuers. However, as the market is maturing, major problems crop up that demand solutions. Some issuers do not use the proceeds for green projects as initially claimed, some do not conduct any post-issuance reporting, and some issuers saw the withdrawal of second opinion review. Since none of these instances are included as commitments in the terms and conditions of green bonds, they are consequently not considered an event of default or put event which would enable the bondholders to accelerate or redeem their bonds.
This oversight puts bondholders in a dilemma. Without contractual provision for effective redress when issuers’ breach their investment criteria, bondholders have no other choice but to sell in the secondary market. If a loss is incurred as a result, the bondholders cannot claim that the issuer is in breach of its green commitments.
It is perhaps no surprise, then, that greenwashing is a high risk for green bonds and many are beginning to take note of its empty promises. In a January 2023 research paper titled “Green Bonds, Empty Promises,” a team of legal experts analysed nearly 1,000 green bonds and interviewed over 50 market participants and policymakers. The researchers not only found a lack of enforce ability of green promises but found that these promises have been getting weaker over time. More specifically, they found that since 2018, the share of newly issued bonds with green promises (ie that the issuer would use the proceeds only for green projects) has declined steadily to only 27% in 2022. This means any company or country can issue bonds that claim to be green without even trying to meet the basic criteria.
No less concerning is the same research team’s finding that approximately two-thirds of all green bonds issued in 2022 have disclaimers that state that a breach of green promises does not constitute an event of default. A similar proportion of green bonds issued that year include a disclaimer that waives the duty of the issuer to fulfil its green promises.
The team concluded their research with the following paragraph: “We analyse the legal terms of the green bond market and find a concerning lack of enforceable promises.
“This seems to be the result of an issuance environment in which issuers have leverage in the presence of strong demand for green bonds, and funds have little incentive to offer transparency.
The lack of enforceability is a latent risk that could potentially be addressed through better certification regimes and improved fund disclosures.”
I think there is a quicker solution to the empty promises of green bonds: incorporate the green use of proceeds and reporting provisions directly into the terms and conditions of the bonds, then make them actionable for bondholders via an agreed put event, if not an event of default. As the market matures and green bonds are increasingly seen by investors as an important tool to address global environmental challenges, it is time for issuers to put some skin in the game.
First published on the Bangkok Post
