Green bonds’ dirtier cousins threaten to ‘greenwash’ industry criteria

The European Bank for Reconstruction and Development and Crédit Agricole CIB were among a handful of borrowers to sell transition bonds in 2019. French bank Crédit Agricole says the proceeds of the 100-million note it sold in November will help finance a switch from coal-fired power to natural gas and convert maritime shipping to natural gas from bunker fuel. Brazilian beef supplier Marfrig Global Foods sold a $500m note in July, pledging to use the funds to buy cows only from ranches committed to stopping deforestation.

That transition bond issue was two times oversubscribed, according to a Marfrig spokesperson. But critics say such bonds end up financing carbon-intensive industries. After all, livestock account for about 15% of global greenhouse-gas emissions, arguably overshadowing Marfrig’s efforts to protect trees in the Amazon rainforest. A feed supplement may help reduce greenhouse-gas emissions belched out by cows, but it won’t solve the problem.

A set of industry guidelines could help allay such concerns, particularly because transition bonds fall outside the current scope of the EU’s so-called green-bond taxonomy. That framework, agreed to in late December, is partly intended to cut down on greenwashing by clearly defining what does — and doesn’t — count as a sustainable activity.

A new working group on transition bonds, which has the support of the International Capital Market Association, may publish guidelines for future deals following its discussions in 2020. “Transition bonds are no silver bullet for financing the energy transition, but nor are green bonds,” says Yo Takatsuki, head of environmental, social, and governance research and active ownership at AXA Investment Managers, one of the group’s co-ordinators. “We need a myriad ideas to tackle this global challenge.”

Drawing a clear line between transition and green bonds may help convince sceptical investors that there’s room for both, says Trevor Allen, a sustainability research analyst at BNP Paribas. “We need to distinguish between them as much as possible — they’re different asset classes,” he says. “It’s likely that many green-bond fund managers won’t buy transition bonds, but rather mainstream investors and those willing to finance brown companies that are making a real effort to change.”

The potential of this asset class means it could exceed the green-bond market by the mid-2020s, Allen says. His forecast factors in another debt market newcomer, the so-called sustainability-linked bond that Italian energy giant Enel pioneered in September. In that case, the proceeds were raised “for general corporate purposes”, not for specific sustainable investments.

The interest cost, however, will jump if the company fails to meet certain environmental goals, a concept already common in the loan market. The 2.65% coupon on Enel’s $1.5bn five-year note will go up by 0.25 percentage point if the company fails to lift renewable installed capacity to 55% by the end of 2021, from 46% in June 2019.

This idea has also proved controversial. On one hand, it aligns a borrower’s bottom line with a smaller carbon footprint. On the other, challenges around transparency and benchmarking may prove a hurdle for some investors. And adding another label brings more complexity. Still, Enel’s deal served as proof of concept, and the company says that $4bn of orders shows that investors were receptive. “It’s about an outcome, not just making the effort. That’s a positive aspect,” says Guido Moret, head of sustainability integration credits at Robeco.

Bond giant Pacific Investment Management has also voiced support for sustainability-linked bonds. Separately, US-based Pimco introduced a fund in December that can buy notes from companies committed to climate action, particularly those with science-based targets. It’s part of an influx of funds moving away from a pure green focus as investment companies recognise the need to deploy capital to a broader range of businesses, as well as the opportunity to differentiate their range of products from those of their peers.

It’s important not to get bogged down in semantics, says Robeco’s Moret. Green bonds themselves are arguably transition bonds. What’s clear, however, is that investors are placing growing emphasis on environmental criteria. Carbon-intensive companies that fail to make and communicate efforts to lower their footprint may eventually see their funding costs increase. Transition bonds can be a useful marketing tool, while also raising the cash that companies need to change.

“There’s definitely a case for transition bonds — the green-bond market alone is not enough,” says Jarek Olszowka, international head of ESG at Nomura Holdings. “That said, we need to safeguard the market’s integrity. Transparency is paramount if we’re to avoid sabotaging the progress that’s been made so far.”

• Gledhill covers the European credit market at Bloomberg News in London.

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