17 July 2019

The Future Is Green (But It Comes in Many Different Shades)

By Nathalie Cuadrado

UK Targets Zero Emissions by 2050—First Amongst G7 Nations

This month the UK government announced its Green Finance Strategy aimed at reducing net greenhouse gas emissions to zero by 2050, a step change from the 2008 Climate Change Act which had set goals to reduce emissions by 80% by 2050. The UK is the first among G7 nations to adopt such a challenging target. Focusing on emissions from homes, transport, farming and industry, the UK’s initiative will likely pressure the remaining G7 countries and other European nations to follow suit. With governments pushing the climate agenda forward, one way to increase investment fast is to tap the still small green bond market.

Growing Fast With Increased Diversification

We have seen a significant increase in green/sustainable bond issuance with growth of 120% year-over-year (YoY) in non-financials and 36% YoY in financials, through June of this year.

Currently, the corporate green bond market is dominated by financials (42%) and utilities (33%). With governments such as the UK pushing the climate agenda forward and looking to boost investment for green priorities, it is likely that a broader range of sectors and issuers could seek to access this growing market. We are already seeing this in 2019 with inaugural issuance from new sectors such as chemicals and retail.

Different Shades of Green?

However, with the diversification comes an increased range of green shading. This highlights the need to differentiate, by analyzing not only the green bond framework but also the issuers’ overall strategies, which can significantly contribute to strengthening or weakening confidence in the green credentials of a bond.

In the utilities sector, eligible projects are generally uncontroversial, such as building wind farms. With the new entrants, there has been a more diverse use of proceeds as green bonds have been used to finance R&D and manufacturing capacity for more energy-efficient products. While these are valid under the Paris Agreement (December 2015) of the U.N. Framework Convention on Climate Change’s 2°C scenario—which “sets out to strengthen the global response to the threat of climate change by keeping a global temperature rise this century well below 2 degrees Celsius above pre-industrial levels”—the key question is where to set the bar to guarantee substance. For example one consumer product company’s target is to improve energy efficiency in its products by 10%, whereas another similar consumer company is looking for a 15% improvement. The green bond framework from a chemical company looks to have a stronger rationale, with part of the proceeds expected to be used to finance R&D and the construction of facilities for EV batteries and energy-storage systems.

Standardization Is a Work in Progress

The EU has made efforts towards standardization and set up a Technical Expert Group (TEG) on sustainable finance to assist it in developing:

  1. An EU classification system to determine if an economic activity is environmentally sustainable
  2. An EU Green Bond Standard (EU GBS)
  3. Methodologies for EU climate benchmarks and disclosures for benchmarks
  4. Guidance to improve corporate disclosure of climate-related information.1
The TEG has recently issued a technical report containing its recommendations on an EU GBS. The core components are green project eligibility, content of the green framework, reporting and verification.

The aim is to set standards of eligibility projects for each industry. We believe this increased standardization will further promote growth of the market.