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Analysis

Green Bonds Require Higher Verification Standards, Says Expert

By Peter Appleby | Tue, 01/12/2021 - 13:15

In September 2020, Mexico joined an exclusive group countries by issuing its first ever green sovereign bond. According to Deputy Finance Minister Gabriel Yorio, the country’s UN SDG-aligned sovereign bond would help Mexico “reduce inequality, promote financial inclusion and reduce the gender gap.”

There was only one problem. While the announcement generated huge interest it offered little proof as to where the US$889.73 million earned by the issuance would be funneled. The bond’s framework promised to finance projects in 1,345 municipalities where access to education, drainage, electricity and health services was limited. But a structured explanation of how that money would be spent was missing.

This problem is not new. Green climate bonds are now estimated to be worth US$1 trillion but rarely is there much information to back their green promises. At best, the hazy evidence that supports green bonds is indicative of the sector’s early-stage maturation, say critics. At worst, it is a clear form of ‘greenwashing’, they argue.

But as green finance grows in popularity and value, its claims are coming under the microscope and stakeholders forking out their cash are demanding stricter regulations to guarantee their funding is used for sustainable ends.

Investors are already asking climate-related questions. They want to see more transparency and clarification of what exactly their investment will finance,” say Carolina Barreto, Program Manager Latin America for the investor-focused non-for-profit Climate Bonds Initiative (CBI). “Investors are as interested in the label given to the bond as much as the details behind it. Mechanisms like external reports are key.”

 

A Green Wave

Sustainable finance is attractive to Mexico, a country where the repercussions of global warning and environmental degradation will have a major economic impact.  

“There is a clear threat from climate change to Mexico, and the country’s role in the Paris Agreement attests to the understanding Mexico has of this threat,” Roberto Ballinez, Senior Executive Director of Public Finances and Infrastructure at HR Ratings told MBN in a recent interview.

The consequences of climate change are already being felt in two of the country’s  major industries, farming and tourism. In Chihuahua, an extended drought recently fueled violent protests against sending water to the US to settle water debts. At the other end of the country in Quintana Roo, Hurricane Delta triggered the world’s first insurance policy for a natural structure. A stretch of the Mesoamerican Reef that helps protect tourist towns near Cancun is now being repaired with the US$800,000 payout it received after being battered by the hurricane late last year.

The entrance of Mexico’s government into the green bond market was a logical move for a country so open to the ill effects of climate change. But the almost US$900 billion in debt purchased by hungry investors swelled federal government coffers and provided capital to an administration with three decidedly non-green flagship projects: the Dos Bocas refinery, the Tren Maya and the New International Airport for Mexico City. The sovereign bond was five times oversubscribed and investor interest amounted to US$4.8 billion, according to Deputy Minister Yorio.

The response to the country’s bond reflects the rising popularity for sustainable investing. Companies, private shareholders and fund managers around the world are eager to be greener. In a recent institution investor survey, investment bank Morgan Stanley found that 80 percent of asset owners already integrate ESG factors into their investment process, a 10 percent increase against 2017. Meanwhile, 78 percent of investors agreed that “sustainable investing is a risk mitigation strategy.”

As the appetite for sustainable investing rapidly accelerates, we see technology and third-party investment managers playing a key role in measuring sustainability and further driving adoption,” said Matthew Slovik, Head of Global Sustainable Finance at Morgan Stanley.

Latin America lags far behind the rest of the world in sustainable, ESG and green issuance, though its presence is growing. According to UniCredit, an Italian banking and financial services company, the region is responsible for only 2 percent of the value of green bond issuances since 2007. In 2020, Latin American bonds provided 5 percent of the US$121.1 billion issued worldwide. Europe, where the sector is more mature, came top in both categories.

 

Standardization

Mexico’s bond was issued under the country’s new “SDG Sovereign Bond Framework” with the support of investment bank Natixis and backing of the UNDP. The presence of widely-respected institutions offered the bond greater integrity and helped appease any worries investors may have had.

But there is no real industry standard for green bond issuance.                    

At present, the green bond issuer decides on the evidence it will offer to support its green claims and decides how to present its evidence. This lack of standardization produces an assortment of bond issuances that vary wildly in the quality of the information verification that they provide, says Barreto

Currently, initiatives like the Green Bond Principals provide frameworks to guide issuers along a path, but it is not very detailed. Taxonomies are complementing this framework by proposing more details and metrics” she explains.

An alternative to following principals is for issuers to go to via second parties, appointed to provide second party opinions. While this offers investors greater certainty, Barreto says that these external reviews do not always go deep enough in their investigations and that, at the end of the day, second-party opinions are just that, opinions. An authoritative voice is still missing.

Standardization is required to bring certainty to this growing sector and, as Barreto points out, it is important to attract international flows..

 

Obstacles to Overcome

But standardization presents its own problems. As so few green bonds are issued from Latin America, there are fewer organizations capable of providing the technical support organizations require to issue green bonds. In Mexico and the Spanish-speaking world, difficulties are compounded by simple obstacles that must be overcome. For example, the majority of the guidance for green bond issuance available is written in English. This is legalese, highly-technical speak, and not easily understood by non-native speakers. For organizations wanting to issue green bonds, the cost of the process to reach the market can quickly mount.

But the regions organizations must take this step, Barreto believes. As more green bonds are issued, the ecosystem of consultants and authorities to provide oversight will evolve and the processes of taking a bond to market will become easier, while information to support the use of funds generated will be more transparent and easily validated. “We need verification that 100 percent of the proceeds go towards green projects because the lack of verification has been the problem in other places. After that, you leave it to the market,” she says.

Photo by:   Nattanan23, Pixabay
Peter Appleby Peter Appleby Journalist and Industry Analyst