Climate change has become an even more pressing issue in 2021 after the extreme temperatures and ecological disasters seen in the northern hemisphere this summer. The goals set by the Paris Agreement to reduce greenhouse gas (GHG) emissions now seem to be less ambitious and more of a minimum requirement.
The Agreement aims to limit the global temperature increase this century to 2 degrees Celsius above pre-industrial levels, while pursuing the means to limit the increase to 1.5 degrees.
If these goals are to be met, then green financing will be needed on a scale that far exceeds anything seen so far to increase renewable energy capacity and maximize energy savings. But to what extent could green bonds, which target climate-related projects with clear use of proceeds structures, play a role?
Demand for green bonds will grow
Growth in the green bond market has been impressive. In less than a decade, it has transformed from a niche impact market to one of the most dynamic segments in fixed income and a mainstream market. The growth started in 2014, when the International Capital Market Association published the first Green Bond Principles, increasing transparency for investors and clarifying requirements for issuers.
Covid-19 temporarily derailed the market. But by the third quarter of 2020, it had bounced back with record issuance of €74bn. Triple-A-rated issuers including Germany, which is building a green yield curve, and Sweden, tapped the market in 2020. There have been sovereign issues beyond Europe too, with Egypt launching its first green bond. Despite the pandemic, corporate issuers continued to issue green bonds too over the course of the year, maintaining their share of the total market at around 40%.
Demand for green bonds can be expected to continue growing strongly. As a result of a positive outlook and the stronger-than-expected green bond issuance seen so far in 2021, we have raised our projection for full-year issuance to €400bn. This will push the global green bond market well above €1trn by year-end, versus €700bn at the end of 2020. We expect the market to exceed €2trn by the end of 2023.
This impressive growth is accompanied by an increasing breadth of issuers. In March, Italy issued a €8.5bn inaugural green bond that was nearly 10-times oversubscribed, and France, the largest green bond issuer, returned to the market with its second green bond. In the corporate segment, more industrial, communication and technology companies are turning to the green bond market to finance green projects, in what was traditionally more the domain of the financials and utilities sectors.
Green bonds are only one factor
The market is clearly growing strongly but what contribution are green bonds making in the climate battle? This is extremely difficult, if not impossible, to gauge. But as a yardstick, new figures published in NN IP’s Green Bond Funds Impact Report 2020 showed that its green bond funds, with €3.8bn under management, saved 561,211 metric tonnes of carbon dioxide emissions during the calendar year, added 333 megawatts of renewable energy capacity to the grid, generated 835 gigawatt hours (GWh) of annual renewable energy and saved 42 GWh in energy.
While green bonds clearly can, and do, make a major contribution to tackling climate change, it is impossible to say how big the market must be to achieve the Paris Agreement targets because the reality is that they are only one of the many factors needed to improve the environment.
The equities market has a role to play, as do governments, companies and individuals. We must all change our behaviour as consumers, reducing travel where possible and recycling more, for example.
Global market expansion
The amount of investment needed to tackle climate change is also colossal: the United Nations Environment Programme (UNEP) $280bn to $500bn must be spent by developing countries annually by 2050 to reach CO2 reduction targets. As much as this year’s green bond issuance is likely to be $400bn, multiples of this are needed in practice.
More diversity of issuance would also help: the reality is that the green bond market is concentrated in Europe. However, the north American and Asian markets are growing, especially in China, and in time they could constitute a significant part of the global market.
There is also sufficient capital. The global bond market was estimated to be around $128trn in 2020, according to ICMA Group, so it is an obvious source of investment in green bonds. The green bond market does indeed have the potential to reach the trillions of dollars needed in the climate battle, especially so with the help of investors with large, fixed income portfolios.
Every fixed income investor can help finance positive change and generate solid financial performance in a market that now gives them far more scope to do so than even one or two years ago.
