As last year drew to a close, cumulative issuance under the Climate Bonds Standard passed the magic milestone of $200bn – setting a bold new benchmark for global investment in green projects and business practices.
Whether in the form of certified green bonds, loans, sukuk or other instruments such as green deposits, leases, commercial paper or repos, Standard-driven debt has now been issued by more than 220 issuers in 40 countries.
Hailed in a January statement from advocacy group – and Standard mastermind – the Climate Bonds Initiative (CBI), the milestone was accompanied by an update on how the protocol has expanded into new industries, and will continue to open up in the coming year.
In 2021, the CBI granted certifications for green investment across five new sector criteria, covering grids and storage, hydropower, bioenergy, geothermal and shipping. This year, the Standard is poised to spread its influence into steel, basic chemicals and cement, which the CBI classes as heavy-emitting, or ‘hard-to-abate’, sectors. The organisation has also set its sights on aviation as a potential growth area.
What will this more open vision of the Standard mean for the relationship between investors and non-financial corporates (NFCs)? The Treasurer spoke to CBI chief executive Sean Kidney to find out…
There is extraordinary appetite for green – and it’s probably useful at this point to explain how that appetite has emerged from the way we work as an organisation.
Essentially, we have all the world’s largest investors on board as Climate Bonds Partners. They’re looking for the inside track on what they ought to consider green, because they don’t necessarily have their own due diligence capabilities – so we’re their bridge to the science.
What we’ve been doing, slowly but surely, is examining different areas to incorporate in the Standard – for example, aviation is on our agenda. So, how can we tell, within that industry, what constitutes a robust investment in the context of Paris Agreement targets? I’ll tell you what it isn’t: incremental improvements in the fleet. It needs to be more substantive than that. Electric flight would count, for instance – and so would biofuel.
So, we bring together expert committees and issue pronouncements backed by their evaluations of a project or business activity’s substance. On top of that, we have a Technical Working Group (TWG) of non-conflicted experts, plus an Industry Working Group (IWG) comprised of actors from banks, investment groups and companies. The IWG comments from a practical standpoint: it can say something is mad, and take that back to the TWG – but as the TWG decides by consensus, it can ignore that feedback if it wants to.
Now, that process has proven remarkably robust – and investors are very happy with the advice it produces.
Take our recent inclusion of hydro. When MSCI started taking our data to create its Green Bonds Index, it added its own filters on top of that – which ended up screening out everything but small-scale plants. That’s largely because investors were wary of hydro controversies in countries such as Brazil.
After spending a couple of years thrashing this out with our expert committees, our line was that it’s not about large vs small – it’s about methane leakage. You can have a large, run-of-the-river mill in Brazil, with minimal methane leakage, and that would qualify – which all comes down to adaptation criteria. No one had thought about that before we started discussing it – not even the International Hydropower Association.
But the world is changing rapidly. From now on, climate volatility is the norm – and if, as a company, you’re not planning for that, you’re simply being negligent. So, we brought the minimal methane requirement into our criteria – plus, on the advice of our TWG, a phrase on indigenous protections. So far, two bonds have been issued against those criteria, and they’ve gone like hot cakes. And that’s because we’ve had a proper process in place to socialise and explain all the underlying issues to big investors.
Another example is grid investment: we need to quadruple the electrification of society by 2050. That mission encompasses a lot of infrastructure. So, again from an adaptation point of view, that creates plenty of scope for optimisation – notably, upgrading grids to support distributed data and other innovations. Anything that supports electrification is welcome, so our criteria are very generous.
Whenever I’ve put this to companies in the grid industry, they’ve said, “Really? Our investors wouldn’t believe that!” Which is right: they wouldn’t believe it until we’ve explained it. What we’re doing is examining the science, and slowly expanding the universe of compliant investments – opening up the Standard to more and more NFCs as a result.
If the economy you invest in is unhealthy, then your longer-term returns aren’t going to be healthy either. And I must stress here: green finance is not about sentiment. Among other things, it’s about managing broader issues around ensuring healthy, longer-term returns.
One of the reasons we work with institutional investors is because, in line with their fiduciary duty, they have a long-term assets and liabilities matching requirement. That often doesn’t exist in companies, especially those that have fallen prey to executive capture and are caught in horizons of between six months and six years – which are far shorter than we can afford in our current circumstances.
So, this activity on the part of investors in the green space is an effort to achieve a better balance in society between the short term and long term. And it’s working.
The green market has tangible price benefits. Whenever there’s a downturn, the valuation of green bonds will stay the same, while other bonds collapse in price. So, they’ve ended up becoming great value-retention tools for fixed-income investors. If, on straightforward valuation grounds, green bonds are worth more, NFCs will get cheaper rates.
But the primary driver here is investor engagement: the relationship you have with your backers – which spills over into equity relationships. If you are able to lock in a bunch of investors around your green story, it’s much harder for a raider to come along and take them off you. And it’s much harder for your share price to tank. People are less flighty.
That’s what’s really driving green finance going forward – and, as we open up the Standard to more and more sectors, the advantages will spread to more and more participants. In real time, we are seeing NFCs deliberately seeking to change their asset and activities base to be able to have those investor relationships. They don’t have to change their entire business. They just have to ensure the business is more consistent with being future-fit – for example, by making adjustments that fall within the scope of the relevant criteria.
Let’s say you’re a supermarket chain: if you are able to demonstrate high levels of energy efficiency in your property portfolio, or the buildings you lease, you can issue green bonds against that. Those bonds will then collectively become an engagement device with your investors – really powerful stuff. And if that helps you as a chain to improve your energy efficiency too, that will align with a key Paris target, which is that by 2050, 40% of our energy savings should come from the built environment.
I mean, a major investor in Sweden recently told me that when a Swedish company issues a bond with no green component, and it gets out that they haven’t issued any previous green bonds either, investors will ask: “Is there something we should know about you?” That’s a huge sign of the direction of travel in the investment community.
Put simply, it will grow the market. If we take a macro perspective on what’s going to happen to capital flows, McKinsey recently said we would need about $9.2 trillion a year to achieve carbon neutrality – which I would slightly increase to provide resilience in the face of climate volatility. So, let’s say $10 trillion per year.
Probably around half of that will become bonds, because we’ll need to have a re-fi component as well as a project finance component. A big chunk of the equity will be sovereign, and a further chunk will comprise other, assorted forms of debt or financing.
Now, in the big picture, it’s important to note that only about $1 trillion of that will be all-new, additional financing. The bulk of the work will be around reorienting the other $9 trillion to be future-fit – and that’s what investors are looking for.
So, lots of corporates are getting the opportunity to show off their green credentials and encourage others to follow them – which is the start of reorienting the capital flows that are already in train. Think of it as more railways and fewer freeways. That’s certainly achievable – but what we must also achieve in parallel is rapid greening through that all-new expenditure. And even in the hard sectors, we’re already seeing a distinct shift.
For example, green steel. I’m aware of seven companies around the world that have active Capex programmes in hydrogen-manufactured steel, whereby green hydrogen replaces the coke. Others are growing their electric arc furnaces to recycle steel, which is also a strong, low-carbon solution.
These developments are unfolding surprisingly quickly – much more so than I thought they would. But that’s the beauty of data: once the fog clears away from the goalposts, the way ahead becomes easier to focus on.
Matt Packer is a freelance business, finance and leadership journalist
