Nomura

Demystifying green bonds

We are increasingly witnessing a global trend for green finance, particularly following the UN Paris Agreement which aims to strengthen the global response to the threat of climate change by keeping a global temperature rise this century well below two degrees Celsius above pre-industrial levels. Financial flow is key to meeting this objective – the International Energy Agency estimates it would require $53 trillion of energy investments by 2035 to have a ~50% chance of limiting a global long-term temperature increase.

The green bond market, which launched in June 2007, aims to increase the amount of investment to tackle global warming and has witnessed significant growth since the inaugural issue by the European Investment Bank. The market has shown much impetus over the past few years: $92.8bn was raised in 2016, and $53bn has already been sold in the first half of 2017. Although the green bond market remains a tiny fraction of the overall debt market, we think the market is likely to expand as the focus on reducing our carbon footprint becomes a higher priority.

Despite the robust growth the green bond market is experiencing, it is not without its problems. The market lacks guidelines and standards, which has been a barrier to secondary market activity. Although different guidelines were introduced to try to better regulate the market, they were voluntary and were not considered global in nature. Furthermore, in the US and Europe, bonds can be self-labelled as “green” by the issuer, with no defined standards to regulate the proceeds. The harmonisation of green bond standards would increase transparency and could increase mainstream investor interest in green bonds.

Although the demand for green bonds often outstrips supply, it is not completely reflected in its secondary pricing as liquidity is often poor. More governmental support would also help unlock further growth in the market. Tax incentives and credit enhancements could also be incorporated into green bonds to increase their competitiveness. One way to help reduce the risk profile of green bonds would be for government agencies to purchase the junior and subordinated tranches.

Robust investor demand and a global move towards reducing our carbon footprint are likely to drive the growth of the green bond market. With the introduction of further standardisation and stringent disclosure requirements, the market should become more transparent and investor interest should increase. The emergence of large sovereign issuers of green bonds is an important step forward, and if this continues, green bonds could become a very important part of fixed income markets.

For further insight on the outlook for green financing and why investors are increasingly seeing such instruments as an attractive investment option, please read the full report on our Global Research Portal.

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