For green bonds investors, the primary goal is to generate a positive environmental impact and contribute to climate change mitigation. Amongst others, the question of additional or incremental impact arises. That is, am I contributing to an additional environmental benefit by buying this green bond comparing to not buying it?
There are two aspects that are quite interesting:
1. Should you only buy green bonds on the primary market?
One could argue that once the green bond has been issued, projects have been financed and therefore the impact is gone. But investors should realize that the impact is in holding the bond rather than buying the bond. The impact is driven by the green projects being operated. Think about a solar farm, your impact is avoiding x tons of CO2 per annum compared to a baseline. This happens over time as the solar farm is operated and not day 1. Impact can been seen as a coupon on a bond that accrues over time, each day you hold the bond the underlying project generates x MWh of electricity and helps avoid x tons of CO2 – your impact as a bondholder. So it should be the holding period that matters to be attributed an impact, not buying at issuance or on the secondary market.
2. Should you consider green bonds where proceeds can be used to refinance existing projects (rather than financing new projects)?
Then comes the more thorny question of whether we should accept issuers that use proceeds to refinance existing projects (projects already live before the green bond was issued). Here you could argue that since the project already existed before “your” green bond, then the bond has no incremental impact. At a time where we need to critically ramp-up climate financing, it’s fair to expect from issuers to finance either new projects or re-finance existing projects that were issued very recently – for an incremental impact. Let’s take a bank that plans to aggressively increase green financing, whether they issue bonds in 2020 to finance projects in 2021 or finance projects in 2021 and then issue green bonds in 2022 doesn’t change much. But if they use the proceeds for projects from 20 years ago, then that is more problematic. Also imagining ourselves in the shoes of issuers – investors are asking you for only “new” projects, but also to have a rapid timeline to allocate the proceeds of green bonds – seems like a headache and reasonable to tolerate refinancing.
And maybe more importantly, the issuers’ sustainability strategy (and particularly its environmental strategy) should be part of the key considerations. The incremental impact also comes from the evolution of the overall stock of green projects of the issuer. So by buying green bonds from issuers with a credible and ambitious environmental strategy, you benefit from that incremental impact. This point is paramount, as a lot of issuers adopt a “portfolio” approach for their green bonds, meaning that they do not allocate projects specifically to green bonds but rather maintain a stock of green assets in excess of green bond outstanding. As long as you’re involved in issuers that will be growing the stock of new green projects, the incremental impact of green bonds is clear.
As a very important point to note, the concept of financing and refinancing will become less and less relevant over the coming decades. As climate financing accelerates and we reach the critical mass of projects required to align with Paris agreement targets, green bonds will mostly exist to refinance existing assets being operated. Their impact will gradually be lower as global CO2 emissions will have decreased significantly – think about operating a solar plant in a country where energy supply is 100% green, you’re saving basically nothing compared to the baseline unless using a more efficient technology. In any case if we do get there in a few decades, that will be a good problem to have a debate about.
