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New Bonds Make it Easy to be Green

Sustainable investing may have been dominated by stocks in the past, but that may be changing as the green bond market continues to become more attractive to both retail and institutional investors. This trend is helping to grow the range of approaches to sustainable investing in the broader fixed income space.

New issuance of green bonds has ballooned over the past few years. Last year, green bond issuance exceeded $47 billion with new offerings in France, Sweden, Germany, China, and India, among others. Compare that to just three years ago, when green bond issuance was just over $10 billion.1

Meanwhile, the overall appetite for sustainable investment products and strategies has grown markedly and now accounts for over $6.57 trillion of assets managed in the United States2 and $21.4 trillion globally.3

As investors become more focused on sustainable investing, green bonds are joining equity-based investments as part of a comprehensive approach to integrating sustainability in their portfolios.

What Is a Green Bond?

Green bonds are fixed income securities for which the proceeds will be used for projects with clearly mandated environmental benefits. The projects typically involve renewable energy, energy efficiency, sustainable land use and clean water.

While similar to traditional bonds in terms of structure and maturity, green bonds are subject to more stringent disclosure requirements regarding use of proceeds and expected impact during specific time horizons.

Since green bonds are backed by the full credit of the underlying issuer, returns are not dependent upon the success of any one particular venture and therefore investors are not subject to project risk. Given that the risk profile of green bonds is in line with that of traditional offerings from the issuer, they will typically trade at identical or very similar valuations.

Green Bond Issuers Evolve

Historically, the green bond market has been driven by supranational development organizations, including the World Bank and International Finance Corporation (IFC), and they continue to be the most active issuers. The World Bank alone has issued over $8.5 billion in green bonds in 18 currencies since 2008. However, corporations, municipalities and government agencies are now becoming important issuers.

Corporations have been increasingly drawn to green bonds to support sustainability initiatives and clean energy projects. A 2014 Standard & Poor’s report found that “corporate issuers see green bonds as an alternative financing avenue, offering access to a diversified investor base, plus a means of implementing and maintaining efficiency measures considered environmentally sustainable.”4

The municipal market also lends itself particularly well to green bonds. State and local governments consistently tap capital markets to borrow money for projects designed to positively impact the lives of residents, such as building schools and hospitals. Looking ahead, a broad swath of issuers is primed to increase green bond issuance, allowing access to a diversified investor pool and greater efficiency.

All Investors Welcome

As interest in green bonds has grown, investing in these instruments has become easier for all investors. Morgan Stanley has set-up sales and trading platforms specifically to ensure that a broad range of retail investors have access to new issue allocations and to the most liquid green bonds in the secondary market.

In addition, as investors in green bonds become more diverse, there may be more opportunity for price tension in the “book building" process, which is when underwriters take orders and seek out price thoughts ahead of launching bonds. This could help the market mature at an even quicker pace.

Growing Pains

There are, however, some growing pains left for green bonds.

One challenge is the divergent interpretations as to how “green" is defined. In response to this lingering lack of concrete definition, third-party groups have emerged to track issuers for the life of green projects and initiatives, thus keeping them accountable for certain standards. Further, financial services firms acting as underwriters have drafted and supported Green Bond Principles, which serve as voluntary guidelines encouraging increased transparency and disclosure.

While equity-based strategies may have lead the way, green bonds will play an increasingly important role as investors take a more holistic portfolio-based approach to sustainable investing. The emergence of green bonds serves as a prime example of the evolving market landscape and points to a future where attractive financial returns and positive societal and environmental outcomes can happen simultaneously.

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