The $5 billion inaugural green bond sale held by the government of Canada in March represented a tiny slice of its overall bond issuance for 2021-2022. Yet the move marked a significant step, as public and corporate issuers around the world are increasingly leaning on green bonds to meet carbon emissions goals. Given the rapidly shifting landscape in this new asset class, what should investors know?
The global market is already expanding at a rapid pace. According to recent figures compiled by the Climate Bonds Initiative, green bond issuances represented roughly half of the overall sustainable debt market in 2021, reaching US$522.7 billion, a 75% jump from 2020. Based on this growth rate, investor expectations surveyed by the Climate Bonds Initiative in October 2021 could very well become reality and lead to issuances of US$1 trillion in 2022 alone.
Green Bond Guidelines
Of course, growth in green bonds might not have been the same had it not been for certification guidelines developed with the help of technical experts, such as the Climate Bonds Standard, which are meant to be consistent with the Paris Agreement’s target of limiting global warming to 1.5 degree C. These guidelines have served to provide a solid foundation for market credibility, ensuring funds go to credible climate projects and promoting third-party verification thereby generating investor interest. As is the case with any security, however, investors should still perform due diligence before acquiring green bonds since continued credibility and ultimate growth of this critical market is in investors’ hands.
The Green Bond Framework designed by the Canadian government is aligned with the International Capital Markets Association’s (ICMA) Green Bond Principles (GBP). These define the security as “any type of bond instrument where the proceeds or an equivalent amount will be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible Green Projects and which are aligned with the four core components of the GBP”. These four components of the ICMA GBP are:
- Use of Proceeds
- Process for Project Evaluation and Selection
- Management of Proceeds
Eligible Green expenditures include projects such as clean transportation, energy efficiency, protection and restoration of biodiversity, terrestrial and marine ecosystems, sustainable water and wastewater management, climate change adaptation and pollution prevention.
Growing Pains in the Green Bond Market
Faced with the same need to address climate change, emerging markets have also been busy in this space. As green bonds continue to expand, China, which hopes to see its carbon emissions peak before 2030, is likely shaping up to be one of the big global issuers with some estimates already forecasting issuances totaling more than US$100 billion in 2022. The Chinese market is still evolving, however, and investors should know that not all green bonds are yet aligned with international standards. For the full year 2020, for instance, only roughly half of Chinese green bonds issued were aligned with the Climate Bonds green definitions. “While a green bond is indeed a commonly recognized sustainable finance instrument in China, the country lacked consistent and unified definitions and classifications of green industries for a long time”, Sustainalytics pointed out in February 2022.
One of the recent changes in the Chinese market has been the 2021 edition of a “Green Bond Endorsed Project Catalogue” by the People’s Bank of China (PBOC), the China Securities & Regulatory Commission and the National Development & Reform Commission. When the Catalogue was made public, the PBOC issued a release outlining its main benefits and mentioning the adoption of “more scientific and precise definitions on green projects”. Thankfully, the PBOC is working on strengthening practices and restricting use of proceeds to go to fossil fuel and coal development. It also referred to a “stable framework” for domestic green bond development.
Green Bond Future Growth
It is against a global backdrop of strengthening practices that the government of Canada issued its inaugural green bond, which was followed by the publication of its 2030 Emissions Reduction Plan underlining the importance of private sector capital to achieve the transition to net zero emissions. “Sustainable finance initiatives can help crowd-in needed private investment and amplify existing climate policy signals in a business-friendly manner,” the government wrote.
With countries pledging to achieve net zero emissions by 2050, which requires capital and robust practices, investors in Canada and elsewhere are likely to pay increasing attention to make sure that labelling, use of proceeds and reporting all align. Many are already showing a healthy appetite.
Demand for the 7.5-year bond (with a 2.25% coupon) issued by the government of Canada was so strong that the final order book exceeded $11 billion, the department of Finance announced in a press release on March 3. Most of the buyers (72 percent) were “environmentally and socially responsible investors” whereas in geographic terms, international investors represented 45 percent of the investor base, it added.
Other participants are already busy in the Canadian green bond sector. One is the government of Ontario, also a member of the GBP, which has been active in the green bond space since 2014-15, issuing $10.75 billion over time. The City of Toronto, for its part, issued four green bonds from 2018 to late 2021, the latest being a 10-year debenture with a 2.2% coupon. The City of Vancouver and the government of Québec have also issued green bonds. For its part, the corporate sector has been active issuing green bonds as well, helping total Canadian issuance reach $39 billion to date.
In its Emissions Reduction Plan, the federal government indicated that it aims to issue $5 billion in green bonds annually. The bond program “will add liquidity and AAA-rated ESG assets to create a more mature, liquid, and diverse market for investors, and support the growth of Canada’s sustainable finance market,” it wrote. If the line-up in March was any indication, future offerings could draw strong demand as well.
The views and opinions expressed in this article are solely those of the authors and do not necessarily reflect the view or position of the Responsible Investment Association (RIA). The RIA does not endorse, recommend, or guarantee any of the claims made by the authors. This article is intended as general information and not investment advice. We recommend consulting with a qualified advisor or investment professional prior to making any investment or investment-related decision.