June 10, 2021

Sustainable Finance: Green Bonds Shine – But It’s Not Easy Being Green

According to this Institutional Investor article, a new study finds that “green bonds” proved to be an attractive safe haven investment during the pandemic:

Climate-friendly debt served as a better protection against large market fluctuations than gold, as well as performing better than other environmental, social, and governance investments, according to new research from Imran Yousaf of Pakistan’s Air University, Muhammed Tahir Suleman of the University of Otago in New Zealand, and Riza Demirer of Southern Illinois University Edwardsville.

In the paper, the trio argued that green bonds were the “preferable safe haven” investment for passive investors hoping to defend their portfolios against the “uncertainty” of the pandemic. Conventional stock portfolios that included green bonds saw the highest risk-adjusted returns during the pandemic when compared against equity portfolios supplemented by gold and other ESG assets, the researchers found.

That’s the good news. The bad news is that – at least on the junk end of the spectrum – green bonds may not turn out to be so green at the end of the day. The problem is that these issuers are disclosing to investors that they may not be able to use the proceeds of the financings for the purposes that they intended. The disclosure I’ve seen is pretty robust (check out the last risk factor on p. S-23 of Dana’s recent pro supp), so investors don’t have a lot of recourse if the proceeds aren’t deployed according to plan, but that doesn’t seem to bother many of them.  Here’s an excerpt from this WSJ article:

Companies that issue green bonds create frameworks specifying the use of proceeds for objectives like transitioning to renewable energy. They also hire third parties to verify that the objectives are being met. If a borrower fails verification, however, bondholders have no legal right to seek compensation. “There are no mechanisms to ensure investors that the green investment will actually occur,” said Mitu Gulati, a law professor at the University of Virginia. “The only conclusion I can draw from that is that investors don’t actually care. It’s so much eyewash.”

The article says that the risk that climate-friendly promises may turn out to be illusory wasn’t a big concern when these securities were issued exclusively by investment grade commitments with long-held commitments to stability, but now, as junk issuers enter the market, the concern is that many of them may discover that Kermit the Frog was right – it’s not easy being green.

John Jenkins