The green shoots of Canada’s green bond market
August 19, 2020
Canada’s green bond market has been growing, but investors would benefit from digging a little deeper to ensure what they’re buying is in fact green and not merely clever greenwashing.
Green bonds are still in their infancy. The world’s first green bond was introduced in 2007 and the first Canadian one was issued in 2012. By 2019, global issuance grew to US$257 billion, driven by both investor demand for environmentally friendly investments and issuers’ motivation to efficiently fund specific projects because the funding cost of green bonds is lower than that of traditional bonds. Green bonds also allows issuers to broaden their investor base.
Issued by either governments or corporations, green bonds are structurally identical to regular bonds. The key difference is that the issuer commits to use the proceeds for green investments, green projects or green infrastructure. They can be issued to fund projects such as clean transportation (public transit), energy efficiency and conservation, clean energy and land management. For example, the Eglinton Crosstown Light Rail project was one of the first infrastructure projects funded via green bonds issuance in Canada. Another difference is the proceeds of green bond issuance are typically paid into the issuer’s consolidated revenue and not in a segregated account. Interest and principal are also paid out as a general obligation and are not tied to the revenues of a specific project. As such, green bonds rank equivalent to the issuer’s traditional bonds and bear the equivalent risk.
Investors should be aware, however, that green bonds are still in their development stage and have experienced some growing pains due largely, in my opinion, to a lack of standardization. To address this issue, the International Capital Market Association endorsed the Green Bond Principals in 2014, which were last updated in 2018. These outline four main guidelines for green bond issuance centred around use of proceeds, the process for evaluation and selection, the management of proceeds and reporting.
While many issuers follow the green bond principles, compliance with these guidelines is entirely voluntary and issuers can self-label as green without a secondary opinion, provided they disclose their criteria. As a result, there can be differences in what qualifies as green. For example, until recently, the People’s Bank of China, which regulates green bond issuance in the country, included some coal power projects to be funded via green bond issuance, putting it at odds with global standards.
To further complicate matters, there are numerous third-party providers that evaluate the green bonds framework to strengthen the credibility of the issuer. These opinions may not always be consistent, increasing the opacity of this market.
In addition to the lack of standardization, some question the impact of green bond issuance on overall environmental conditions. While green bond issuance is a method of segregating the funding source for various projects, it is not clear that it necessarily leads to a higher portion of environmentally sustainable projects overall. Perhaps time (and studies of the topic) will tell.
Finally, investors may want to consider the liquidity impact of investing in green bonds relative to traditional bonds. Typically bonds with lower issuance size experience lower liquidity in secondary markets and investors demand compensation for this lack of liquidity in the form of higher yields. However, green bond issuance size and liquidity tend to be lower, but their yields do not rise commensurately. This is not to say that green bonds are a poor investment, but investors should be aware of all factors in making their investment decision.
Over time, I expect that the market will evolve to standardized criteria for the issuance of green bonds, thereby making it easier for investors to evaluate the merits of their investment using an apples-to-apples comparison. Until then, investors are advised to do their homework in evaluating the true greenness of the green bonds they are considering.
Catherine Heath is a vice-president, portfolio manager at Leith Wheeler Investment Counsel. These views are those of the author and not necessarily those of the Canadian Investment Review.