Green bonds are bunkum

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“Green bonds” bucked the broader anti-ESG backlash, with record issuance of $385 billion in the first half of the year.

Along with nice-sounding related stuff collectively called “GSS+” — because absolutely everything needs a marketing acronym these days — that’s now a $5 billion market, according to the Climate Bonds Initiative.

However, to what extent is the greenery just a gimmick to dress up standard corporate loans? How much is it legitimate? Almost none of that, according to a new NBER paper by Pauline Lam and Jeffrey Wurgler of NYU’s Stern School of Business.

Highlighting FT Alphaville in bold below:

Green finance emphasizes “additionality”, meaning that funded projects should deliver distinct environmental benefits beyond standard practice. However, analysis of US corporate and municipal green bonds indicates that the vast majority of green bond proceeds are used to refinance existing debt, continue existing projects, or initiate non-green projects that are new to the issuer. Only 2% of corporate and municipal green bond proceeds initiate projects with distinctly new green features.

The economists studied the “use of proceeds” and other disclosures for about 200 initial green bonds issued by U.S. companies and municipalities between 2013 and 22.

They didn’t grapple with the true environmental impact of what the issuers claimed, they just looked for “additionality” – the green industry’s own term for some kind of improvement in an environmental aspect – for example, a reduction in emissions – over some sort of baseline.

The finer details of the results were almost hilariously bleak. FTAV’s own emphasis below:

In our sample, about 30% of aggregate corporate green bond proceeds and 45% of aggregate municipal green bond proceeds simply refinance existing regular debt! A small portion of green bond proceeds, 3% from corporations and 2% from municipalities, is used to purchase green assets already in use by another owner, an activity that has no economy-wide additionality component. Most remaining green bond proceeds are dedicated to either expanding a project that was already underway or are used to initiate a new project that is similar in its essential environmental aspects to ongoing or previous projects.

As our sample only includes first green bond issues, these previous or ongoing projects would have been financed by traditional means until now. Such “expansion” projects account for 32% of total corporate green bond proceeds and 26% of total municipal green bond proceeds in our sample, and new traditional green projects consume 33% of our total corporate green bond proceeds and 25% of total municipal green bond revenue. Only a handful of green bonds in our sample, accounting for 2% of proceeds for both corporate and municipal issuers, finance a project whose green aspect appears genuinely new to the issuer.

The distribution of additionality is similar for both larger and smaller issues and across sectors. Overall, the results do not support the view that green bonds drive capital to environmentally beneficial uses that are outside the issuer’s norm.

If you think investors would balk at greenwashed bonds with a premium average yield of 0-2 basis points – or that the green index or rating providers would penalize these bonds – then think again.

Investors and market participants also do not distinguish between levels of additionality: bid returns, announcement effects, green bond index inclusion, and green bond fund holdings are not correlated with additionality.

A few caveats. The study only looked at US green bonds, but the bulk of the issue is in Europe. US issuers are likely to be slightly more. . . opportunistic and flexible when it comes to green bonds.

A good example is the green bond issued by the Massachusetts State College Building Authority in 2015 to build a parking garage (because it included some charging stations for electric cars). The European standard for green bonds is more onerous.

Furthermore, additionality is itself a fuzzy measure. Really worthy projects can have negligible additionality, and you can massage the assumptions or add some token gestures to make almost anything look positive additionality.

For example, as FTAV understands things, a hydroelectric dam or recycling center that was going to be built with conventional bonds anyway would have no additionality. On the other hand, if you promise to use environmentally produced materials, a new oil pipeline might qualify for the additionality required for a green bond.

Still, as Lam and Wurgler conclude, the results are “leading”:

The rapid growth in green bond issuance would appear to be cause for optimism regarding environmental challenges, but this growth may overestimate the real and functional response of the bond market.