Alexis Bienvenu

Green Bonds

Are “green” bonds, linked to environmental projects, bringing a “green revolution” to the financial markets? Or are they ultimately just a “green flash” – a mirage, beautiful but brief?

In view of this market’s recent developments, the green flash theory seems most apt.

For the first time in its history, the volume of green bond emissions declined year-on-year: from $596 billion in issues in 2021 to $443 billion in 2022, according to the Climate Bonds Initiative. That’s a 25% drop. Still, the truth is that no corner of the fixed-income sector was spared in 2022. With inflation surging, the central banks began driving rates sharply upward, tipping the bond market into chaos. In truth, so-called green bonds provided no special protection. Indeed, they fell even further than traditional bonds: -17% for the Bloomberg MSCI Green Bond TR hedged USD compared to -11% for the Bloomberg Global Aggregate TR Value hedged USD in 2022.

But their greenness had nothing to do with it. We may not like it that they are less diversified by sector and instrument, since the market is still brand new. But this is no condemnation of their “green” concept.

Besides, 2023 started out on the opposite foot from 2022. January’s issues totalled €39 billion[1], up 25% on January 2022. Many banks are predicting that issues will return to their 2021 level in 2023.

Clearly, this is just the start. For if the growth of the last decade resumes or is indeed spurred on by the new government plans in the US (Inflation Reduction Act), Europe (Green Deal) or China, boosted by investor appetite and the assorted pressures for a lower-carbon economy, the Climate Bonds Initiative is aiming for $5 trillion in annual issues starting in 2025. That would make for an extremely liquid market. China is making promising efforts in this regard. In fact, despite its still largely coal-dependent economy, it was the top Green Bond issuer in 2022. No doubt the rest of these countries will not yield the podium without a fight, which should further drive up green issues – and, hopefully, drive down CO2 emissions.

But even if 2022 does turn out to be just a blip in terms of green bond issues, it may also be the start of another trend: a distrust of responsible investing, which we are seeing especially in the United States. We saw the world’s second-largest asset manager, Vanguard, leave the Net Zero Asset Managers Initiative at the end of 2022. This headwind could slow down green initiatives. Yet in the face of the widespread move toward a more sustainable economy, it’s hard to imagine green financial products being severely undermined by this movement. The market will just have to deal with it.

And a final – but critical – hurdle is threatening the growth of green bonds and, more broadly, “sustainable” bonds. Not necessarily their price, which is, admittedly, slightly higher than traditional bonds – but investors seem ready (up to a point) to overpay for a security they find useful in other ways. The real risk, of course, is of being deceived about a project’s environmental value – greenwashing – which can undermine investors’ trust. In its 2021 report, the Climate Bond Initiative estimates that just 20% of green bonds have standards high enough to earn certification. To expand the green market, we need to see that figure rise to 80% or more. The road is still long, and wide, and Europe should not take it alone.

So if green bonds are to be included in portfolios, they still have to demonstrate that they’re green beneath the surface. Only then will the green flash have any staying power. Meanwhile, it will be up to investors to examine the actual environmental value of every green bond. And they can only do this through expert active management. So the next revolution in finance could be as green as it is active.

This month’s Editorial by Alexis Bienvenu, Fund Manager at La Financière de l’Echiquier (LFDE).

[1] Amundi

Disclaimer: The opinions expressed in this document are the author’s own. LFDE shall not be held liable for these opinions in any way.