Caveat Emptor: A Booming Green Bond Market is Full of Pitfalls for the Unwary Emerging Market Investor - Nick Whittle
Caveat Emptor: one of the biggest talking points in ESG investment today, and I can assure you it’s one which needs to be answered quickly. In a world that is clamouring for more securities into which ESG-conscious investors and ESG-mandated funds can place their money, how do you ensure that the issuers of this paper — so-called ‘green’ bonds — are living up to the promises they made about the usage of these funds?
It’s not just a question of whether or not capital is put to the use for which it was originally raised. The concern is also about the broader behaviour of companies and governments toward their sustainability goals, and toward global investors in terms of transparency and reporting. It strikes right to the heart of the same arguments about risk that have always dogged emerging market investment:
For instance, an Indonesian bank, an Indian power company, or a Chinese manufacturer may secure more favorable borrowing terms by labelling their issues ‘green.’ But how much do you actually know about all of their activities to be able to safely invest? The regulatory frameworks for transparency, reporting, and sanction in the major markets provide the same kinds of protection to investors about ESG compliance as they do for most areas of corporate behaviour. Can you be sure the same holds true in emerging markets that do not yet boast the same regulatory rigour?
According to Bloomberg, Aegon Asset Management calculated that demand for green bonds has soared from a global issuance of $38 billion in 2015 to $226 billion last year. In the third-quarter last year, issuance hit a record $85 billion, representing 69% growth year-on-year. Yet, James Rich, a senior portfolio manager at Aegon, estimates about a third of bonds designated as green contain elements of greenwashing, up from around 20% in just a couple of years.
Other concerned market professionals concur. Mark Dowding, BlueBay Asset Management’s chief investment officer, told Bloomberg that green bonds “only have merit to ESG investors if the issuance leads to issuers actually changing their behaviour.” He concluded that if this is not the case, then green bonds are either just cashing in to secure more favorable borrowing or are guilty of greenwashing.
Many of the world’s largest investors are taking matters into their own hands, by hiring analysts or outside experts to provide deeper understanding of the issues that cross their desks and the ESG challenges they need to address, in order to avoid possible detriment from investment decisions. For example, Lombard Odier is developing proprietary models for assessing an issuer’s green credentials, including past and present deforestation, and damage to habitat and biodiversity, as well as building out its in-house capabilities to analyse environmental and sustainability impacts.
Certainly, emergent standards for ESG reporting will help. The European Union is working on a set of standards that will require issuers to provide more rigorous disclosure and accountability, while in the U.S., the SEC is actively investigating misconduct in securities targeted at ESG investors and funds.
Which brings us back to my point at the start of the article:
If you already have your doubts about the behaviour, transparency and reporting of companies in certain markets or jurisdictions, why would you think that their ESG-linked issues would be any different?
The onus is on institutional investors to increase their investment in analysis and oversight of these assets. Caveat Emptor.
You can read the original Bloomberg article here.
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