Why green bonds matter - it may be more than you think

Investors around the world are seeking ways to both safeguard their financial interests and contribute to a sustainable future.  At the same time, much greater investment is needed to address global challenges including climate change, biodiversity loss, and poverty. For well over a decade, bond markets have provided opportunities to confront these challenges and help achieve the Sustainable Development Goals (SDGs). Starting with the first green bond issued by the World Bank in 2008, investment in green, social, and sustainable bonds supporting environmental and social projects has grown to almost USD 4 trillion. While this growth is impressive, such bonds are still a niche part of the USD 100 trillion bond market. What will it take to realize the potential of sustainable investing? 

"Starting with the first green bond issued by the World Bank in 2008, investment in green, social, and sustainable bonds supporting environmental and social projects has grown to almost USD 4 trillion."

Transparency is key to green and sustainable investing 
In a word, transparency will be critical – and here, green, social, and sustainability labeled bonds are playing a key role in the growing focus on transparency to weigh sustainability risks and opportunities. Labeled bonds provide investors with specific data on projects being supported by an equivalent amount of their funding.  They also are illuminating the importance of the bond issuer’s sustainability approach and activities – and not just the slice of projects eligible according to the label, but all of the issuer’s activities. For example, when considering whether to invest in a labeled bond, investors typically want to know what types of projects the company supports and how the projects contribute to the SDGs. They also have broader questions about the sustainability of the company’s other activities, such as how much water they use and where they get it, the company’s carbon footprint and efforts to transition to a low carbon economy, and how the organization invests in human capital.  

For the next generation of bond investors, asking these types of questions will be just as common as asking, what’s the basis point spread to the benchmark? Today investors are increasingly seeking out this more holistic level of transparency to evaluate a company’s entire balance sheet for sustainability risks and opportunities.  And while labeled bonds provide detailed information on a slice of projects, the risks investors are taking are based on the issuer’s overall activities. 

Investors don’t yet have all the information they need to price in the costs and benefits that go beyond their traditional investment models. Such information may include greenhouse gases causing climate change, pollution causing health problems, or natural systems valuable to the climate and society. Equipped with information about the full activities of the firms they are supporting, over time investors will be able to increasingly implement sustainability strategies that (1) more accurately price risk, (2) seek out investment opportunities, and (3) support positive impact. With better data, investors pursuing the best risk and return strategies will implement strategies that accomplish these goals – leading to a future where all capital market decisions can truly promote sustainability. 

Top-down reporting initiatives complement transparency provided through labeled bonds 
Meanwhile, global efforts that require transparency and disclosure at the corporate level have increased, with regulatory and standard-setting bodies seeking harmonization and common metrics. While labeled bonds initially led to requests by investors for information from the “bottom-up” –i.e., detailed information about projects supported by labeled bonds -  this need for information is also leading to “top-down” approaches as global regulators and standard setters increase transparency through the adoption of international sustainability standards. These additional disclosures can help investors channel funds to the most efficient places based on risk and return. Such wholesale approaches to transparency will enable better comparisons and allow investors to consider an investment’s full cost to society in light of measures such as carbon pricing (which has advanced, but has a long way to go), calculating external costs and benefits, and establishing the economic value of nature.  

Capital markets are transitioning to a new model 
Fifteen years after the first green bond was issued by the World Bank  -- and almost a decade after the World Bank transitioned to labeling all its bonds ‘Sustainable Development Bonds’  to communicate its holistic approach to incorporating sustainably into all its activities -- financial markets are still in a transition period, but change is accelerating. Markets are moving forward from the early stages of enhancing transparency for risk management and impact investing (as captured by labeled bonds) to the next phases, bolstered by increased reporting. We are seeing a holistic approach to sustainability and disclosure emerge for all bonds – not just for a small portion of labeled bonds.  And while continuing to grow in volume in the short and medium term and having jumpstarted sustainable markets, there may be a time where there is less need for labeled bonds. The data and transparency that were the foundations of labeled bonds could become the norm market-wide, providing the insights necessary to understand the true environmental and social impact of investments on people and our planet.