This market has in fact grown so fast that there is a chance of a so-called green bubble developing: excessive demand for green bonds coupled with too little supply. This could also result in increased greenwashing, i.e. non-sustainable investment instruments being labelled as green, because that allows funding to be obtained more cheaply. These are two effects that could create a bubble and thus make sustainable investments slightly less sustainable.

Yet I would still rather have a green bubble than slip on a brown banana skin, in other words: invest in brown stocks or bonds that may in the long run prove worthless.

A paler shade of green

Last year a record amount of USD 157 billion in green bonds was issued. According to CBI, the Dutch centre for the promotion of imports from developing countries, this amount will grow by 60% to USD 250 billion in the current year. That is a lot of money, but still represents only around 1% of the total market. In addition to companies and investors focusing on sustainable power, several governments have also discovered this green instrument as a means of raising capital for sustainable purposes. Poland was the first mover, in 2016. Earlier this year, Belgium issued its first green bond, primarily to fund investments in infrastructure, such as rail roads. Indonesia also issued its first green bond last month. This 'sukuk' is structured so that it complies with the Islamic prohibition to pay interest.

These three examples also illustrate the issues that these types of instruments entail. These issues mainly concern the definition and scope of sustainable investments: the Polish economy relies on coal for 80% of its energy requirement and is therefore far from sustainable. Indonesia is the largest coal exporter in the world and has also cut down large parts of its primeval forests to make room for the monoculture of palm oil plantations. The money raised with the sukuk may not be used for fossil fuels but could possibly be spent on deforestation. This can hardly be called green.

In Belgium the objective appears to be to take some of the pressure off the government budget, as investments in infrastructure are part of a govenment's normal expenditure. However, by labelling bonds as green, a government can add investors with green mandates to its funding pool and thus reduce costs.

Hans Stegeman, Head of Research and Investment Strategy Triodos IM
"I would still rather live in a green bubble than slip on a brown banana skin"

Green bubble

As these examples show, the definition of a green bond is not always clear-cut. There are several criteria that can clarify that definition and bring it more into focus. First, the company or institution that issues the green bond must itself also be sustainable. An oil company issuing a green bond is just not right, even though the proceeds will used to fund sustainable activities. There is always a chance that funding will be shuffled about on the balance sheet, so that the relatively cheap green funding might still be used for brown activities.

Second, green bonds must genuinely be intended for (re)financing sustainable investments. This must be demonstrated at the time of issue by the strategy of the issuer and subsequently by the impact reports for the sustainable investment. And of course, the application and qualification processes must also be in order: transparent, traceable and verified by a third party. Anyone can say that they are green, but this needs to be genuinely the case.

The European Union is also working on recommendations for improving the standardisation of the market for these types of bonds and to ensure that green really is green. These kinds of initiatives help to prevent greenwashing. Meanwhile, the great demand for green bonds has overall not yet resulted in a large differential between the issue prices for green and non-green bonds. This seems to be due to concerns that if the yield on green bonds at the time of issue is (too) low, this could prevent this market from maturing. Nearly every issue is, however, heavily oversubscribed and in secondary trading we do see a price differential. So, green labelled bonds are very popular.

Brown banana peel

The reason why many market players welcome greening is of course the brown banana skin, i.e. the growing risk that oil companies or diesel car manufacturers, for instance, will become stranded assets - investments that will require substantial write-downs in the years ahead. You would think that most investors would rather avoid such slips. But this concerns a much greater proportion of investments than the green niche of 1%, because the global economy is still far from sustainable.

A much more important question than whether or not a bubble will develop in the market for green bonds, is therefore actually why many investors think that they can keep avoiding the brown banana skins. Because if they take a good look, they will find that their portfolios contain quite a few of them. It is hard to stay on your feet when the pavement is littered with banana skins.

This is a translation of a column by Hans Stegeman, which appeared on Fondsnieuws.