Investors: climate funds need supervision – 09/19/2023 – Market

With governments around the world investing billions of dollars in the transition to a low-carbon future, banks are key players in financing wind, solar and other clean energy projects. However, financing tools have drawbacks that can undermine sustainability goals.

That doesn’t stop investors from pumping money into renewable energy financing. In the first six months of 2023, US$18 billion (R$87 billion) was directed to environmental and social bond funds around the world — almost matching the US$22 billion (R$107 billion) raised in the entire year 2022, according to Bank of America.

Almost half of investments in sustainable bonds were directed to European funds, BofA said. In the United States, the flow of sustainable bonds reached US$1.7 billion (R$8.2 billion) in the year to June 2023, compared to US$819 million (R$3.9 billion) up to May .

“Green bond supply has seen impressive momentum this year,” Morgan Stanley noted in a July report, after the first two quarters of 2023 set issuance records: US$176 billion (R$854 billion) and US$185 billion (R$898 billion), respectively.

Countries or companies issue green bonds to pay for specific low-carbon development projects. They follow voluntary standards developed by the International Capital Markets Association or the Climate Bonds Initiative. However, there is a lot of leeway in the definition of a “green bond”, which can raise concerns about greenwashing.

For example, in the United Arab Emirates, Masdar — the country’s state-owned renewable energy company — issued a US$750 million (R$3.6 billion) green bond in July. But Morgan Stanley said this deal was “somewhat controversial” because the UAE as a country is a major oil producer.

While green bonds remain banks’ safe debt tool for sustainable finance, other products are gaining popularity. Sustainability-linked bonds (SLBs) link a company’s debt interest payments to its climate pledges, punishing them with higher interest rates if they fail to meet environmental targets.

Companies like these bonds because they don’t impose obligations on the business to meet goals like reducing emissions or water use or revamping their supply chains.

However, analysts suggest that the rate increases built into the terms of the bonds have been too small to encourage companies to improve their performance. Likewise, some pension funds and environmental investors have quietly stated that they do not believe SLBs finance rigorous projects to combat climate change.

The Italian energy company Enel, which operates in Brazil, was the first to issue a bond linked to sustainability. Since 2019, it has issued a total of US$29 billion (R$141 billion) in different negotiations. Chile became the second largest issuer of bonds linked to sustainability, with a total of US$8 billion (R$39 billion).

In July, Chile issued the first sustainability-linked bond in Chilean currency. Heathrow Airport also issued a sustainability-linked bond worth £650 million. The objectives cited in this paper include the goal of reducing emissions.

Banks have a responsibility to show their corporate clients that there is cheap and abundant financing available for climate-related commercial projects, says Mona Dajani, partner at law firm Shearman & Sterling and global head of renewables.

“But this comes with the enormous burden of oversight,” she adds. “Banks need to work with their industry peers not only to establish their own standards, but also to establish what amounts to a compact for collective enforcement.”

Banks themselves have net-zero emissions targets and are using green bonds to finance their carbon reduction projects. In July, two of the three largest green bonds were issued by banks.

Japanese bank Mizuho issued the largest, worth US$1.4 billion (R$6.8 billion), and Norway’s DNB issued another worth US$1.1 billion (R$5.3 billion) . Of the US$23 billion (R$112 billion) in green bonds issued by companies in July, US$6.5 billion (R$32 billion) came from the banking sector, according to Morgan Stanley.

“In the last year especially, we are seeing an increase in the momentum of green bond issuance by banks,” says Dajani.

But she also notes that “it is difficult to confirm a single number for how many emissions have been eliminated or how much renewable energy has been added to the grid through sustainable debt financing.”

This is largely due to a problem of inadequate standards, she explains, highlighting that what constitutes a green bond is poorly defined and data is confusing about the outcomes of products financed by green bonds.

“Green bonds are worthless if their resources are allocated to a project that would have been carried out anyway, to a project that will not produce lasting results or if the results of their financed projects are ambiguous in relation to the project itself”, says Dajani .

Daniel Green, professor of finance at Harvard Business School, agrees that the biggest challenge with green bonds is that “they are primarily used to finance investments that would have been made even without access to green bonds.” About a third of global green bond issuance is used to finance energy projects, he highlights, while the majority of proceeds finance transport and construction projects.

“While these projects are in some ways more sustainable, they almost always increase rather than reduce emissions,” says Green, citing as an example a recent green bond deal to finance the expansion of Hong Kong’s international airport, which would add a runway to alleviate air traffic congestion.

Now, green investments face a cycle of higher interest rates in many developed and developing countries. In general, higher rates harm new investments — from homes to infrastructure projects. But green projects may have some immunity, Green believes.

“Some green projects may be protected because subsidies and regulations make them attractive regardless of financing costs,” he says. “On the other hand, more discretionary green spending could be heavily cut in a high-rate environment. This pattern has manifested itself, for example, in the recent slowdown in electric vehicle sales.”