Tag: Impact Investing

Central banks must be leveraged to avoid massive risk from climate change — and they’ve only just begun.

In case heat waves, raging fires and monster hurricanes were not enough, the latest IPCC Assessment Report reminds us in no uncertain terms that this decade is our last chance to avoid an utterly catastrophic climate breakdown.

The headlines are stark, but the reality is that we have in hand the powerful financial tools we need to shift the global economy from its current high-volatility risk, carbon-fueled path to a lower-risk, sustainable and resilient future: and central banks are at the heart of that.

Central banks have the responsibility to examine and manage forward risks to the financial system and the economy underpinning that system. That includes ensuring material risks — like the impacts of climate change — are adequately disclosed, and that risk mitigation measures are taken wherever possible.

For many central banks that includes aligning their asset purchasing programs with supporting risk mitigation — investing in green bonds, for example. However, as modeling by the Network for Greening the Financial System (NGFS), an association of more than 90 central banks, has shown, shifting portfolio emissions requires more than green bond purchases; fossil exposures must also be severely limited.

The pressure is on. Climate forecasting group Inevitable Policy Response (IPR) cites regulator fears of climate-based financial instability as one of the underlying forces that will accelerate climate policymaking to 2025.

IPR also sees extreme weather events and civil society pressures, among other drivers, exerting continued pressure on policymakers to take rapid action in the lead up to the COP26 summit in November — and that’s on top of the substantial 2030 emission reduction commitments major economies made at the Biden Climate Summit.

Reaction to the extreme weather events in the first half of 2021 bears out this assessment, and the growing discussions at G20 Finance and Central Bank Governors summits around sustainability and stability, are signals that sharper decisions on global financial regulation will emerge in the immediate years ahead.

Among the leaders is DNB, the Netherlands central bank, which has recently launched its Sustainable Finance Strategy covering risk management, research and data and monetary operations. The ECB’s new climate action plan promises alignment of monetary policy with the Paris Agreement, (For a deeper dive into those landmark commitments, here’s recent analysis from CBI). We hope that COP26 will see the launch of many more sustainability strategies by central banks.

At the end of the day, it’s about better management of risk, very substantial risks.

Article by Sean Kidney is founder and CEO of Climate Bonds Initiative, an international investor-focused non-profit that is working to mobilize the $100 trillion bond market for climate change solutions.  

Related content:

U.S. banking sector far more exposed to climate risk than previously thought

Insurance companies face a climate reckoning

Reprinted with permission from Climate & Capital Media, a strategic partner with GreenMoney Journal.

Sustainability-linked bonds could help finance the transition of carbon-heavy companies, but only if the issuers are serious about climate. 

The green bond market is on fire, channeling record funds into climate-friendly projects around the globe — and at a relatively low cost to issuers. Green bonds offer a promising synergy between investors with trillions of dollars chasing ESG products and the need for climate finance, especially in developing countries where access to affordable debt is essential to install those solar arrays, wind turbines and other infrastructure to underpin a new green economy.

But there’s another piece of the puzzle: Can we also funnel money into the transition of carbon-intensive industries to support their transition to a clean economy, breaking the addiction to fossil fuels? In a perfect world, this is where a newer product, Sustainability-Linked Bonds (SLBs) could play a role.

SLBs are still very much a work in progress. So it’s fair to ask: When a global coal developer raises $300 million through an SLB, does it really help finance the transition, or just raise cheap capital to continue business as usual? More on that real-world example shortly, but first, some background.

Most green bonds are labeled “green” by virtue of their use of proceeds — predetermined projects that mitigate or build resilience to climate change. High-quality green bonds typically align with one or more of the predominant green finance frameworks, which lay out what qualifies as green, along with verification and reporting standards.

This is a hugely successful model for funding green infrastructure. So far in 2021, green bond issues have hit nearly $356 billion globally, compared to about $300 billion for all of 2020, according to the nonprofit Climate Bonds Initiative (CBI). And with asset managers of trillions of dollars seeking investments to green their portfolios, green bond issues will likely hit $1 trillion annually by 2023, perhaps even in 2022, according to Sean Kidney, CEO and founder of CBI.

Flying the Plane While Building It

The SLB market, with its first issue in 2019, is just taking off — hitting issuance of $32.9 billion in the first half of 2021, up from zero in the same period of 2020. It’s tiny compared to the whole labeled bond market, but growing fast.

Sustainability-linked bonds, not to be confused with sustainability bonds, raise funds for general use rather than pre-specified projects. And SLBs are structured so that the yield is linked to the issuer’s ability to meet climate transition goals or “key performance goals” such as certain carbon emissions reductions that are set by the company. If the company fails to meet these KPIs, they agree to pay a higher yield, say 25 or 30 basis points more, to bondholders.

In essence, the issuer pays less for capital if they meet their climate targets. Raising money in this way creates an incentive toward sustainability for companies that are just beginning the transition process, especially in hard-to-abate sectors.

Even though the market lacks a set of standards for setting performance goals, verification and reporting, there is a growing number of SLB issuers raising money, and some are certainly raising eyebrows.

Having It Both Ways

Back to that coal giant, Adani Group, based in Ahmedabad, India. In July, Adani Electricity Mumbai Ltd. (AEML), a utility under the conglomerate’s transmission subsidiary, raised $300 million through an SLB.

AEML’s bond lays out an ambitious plan, with short-term key performance indicators (KPIs) to increase the renewable energy in its portfolio to 30% by 2023 and then to 60% by 2027, from a current level of 3%. It maps its goals to U.N. Sustainable Development Goals and the Paris Agreement and stipulates step-ups in the coupon rate if the company fails to meet its goals.

The issue was “oversubscribed 9.2x by high-quality real money global investors …” the company press release trumpeted. Impressive right?

But in the bigger picture, not so much, according to Tim Buckley, an expert on the energy market in India for the Institute for Energy Economics and Financial Analysis (IEEFA). In his view, a sustainability-linked bond in a green subsidiary merely frees up capital for Adani Group as a whole to continue business as usual – and that business is building coal capacity at an alarming rate.

The conglomerate, under patriarch Guatam Adani, has six listed companies. While one company, Adani Green, is an aggressive leader in installing renewable energy infrastructure in India, another is profiting from coal imports, Adani Ports, and yet another, Adani Enterprises, is perhaps the biggest private developer of new coal capacity in the world. Adani Transmission supports both the renewable and the fossil-fuel sides of the business.

“Practically, the conglomerate runs as a single group,” with Guatam Adani as controlling shareholder and chairman of all six listed companies in the group, says Buckley. “They have intercompany loans left right and center. They have intercompany transactions left right and center. They have behind-the-scenes unsecured, undisclosed loans left right and center and they transfer assets willy-nilly just to facilitate the greenwash.”

SLBs: The Promise and the Limits

There are climate finance forces at work to create order and consistency in the SLB market. One challenge is to allow flexibility so hard-to-abate sectors can access financing for a transition to a cleaner business model, without leaving the door wide open to greenwashing. Another is to require goals or KPIs that are sufficiently ambitious without being unreachable. It’s a fine balance.

SLBs as they currently exist also present another major problem: They seem to reward investors with higher returns when the company they invested in fails to reach its climate transition targets. That seems counterintuitive if the goal is to drive investment to climate solutions.

So for now, the SLB market includes an array of the good, the bad and the ugly. While climate finance experts hash out the proper framework for SLBs, green investors are left to scrutinize individual companies to determine their ambition, roadmaps and, perhaps most of all, their sincere commitment to making a transition to climate-friendly business.

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Article by Kari Huus, managing editor for the US Green Bond Review from Climate & Capital Media. She was a long-time reporter for MSNBC.com, with stints covering international business, foreign policy, and national affairs. Earlier, she covered China for the Far Eastern Economic Review and Newsweek in Beijing. 

Wind turbine image courtesy of Praxis Mutual Funds

INTRODUCTION

With the recent announcement that the European Union will begin issuing green bonds starting in October of 2021 and predictions that have annual green bond issuance hitting $1 trillion by 2023, many have been left wondering: “What exactly is a green bond?”

Green bonds allow investors to buy bonds that make a specific impact on the environment, often with specific attention to climate. Green bonds first came to the U.S. market in 2009 with an International Bank for Reconstruction and Development (IBRD) issuance. The green bond market started slowly, but a slow and steady start has led to the strong and diverse market of today. Successes in the green bond space later led to the introduction of social and sustainability bonds. Recently, the issuance of positive impact bonds has grown to include new categories, such as blue bonds and sustainability-linked bonds.

For many investors and clients, it can be exciting to learn that by actively lending to issuers who are making a positive impact, they are able to support a variety of life-altering causes such as bettering the Earth’s air quality, educating children, providing affordable housing and more.

Traditionally, investors who wanted to make an impact were more likely to “screen out” bonds that had negative societal impacts. However, investing in positive impact bonds allows investors to make a greater, more diverse and more intentional impact.

Current Trends in the Green Bonds Space

Scathing climate reports like IPCC climate report released in August 2021 and growing concern about climate change has led to accelerated growth in the green bonds space. The green bond market continues to grow at an exponential pace, with cumulative green bond issuance surpassing $1.2 trillion in 2021. Additionally, when thinking about the breadth of the green bond market, it is important to note that there has consistently been strong issuance in different maturity buckets and across different rating categories.

In the U.S., the social and sustainability bond issuance has been lower than that of green bonds, but these markets have grown substantially in recent years, with a huge increase in 2020. The COVID-19 pandemic and racial justice movements are partially what spurred growth in social bond issuance starting in 2020. For example, this commitment to racial justice can be seen in the financial corporate bonds that went to supporting black-owned banks. Similarly, the COVID-19 pandemic catalyzed the sustainability bond issuance in 2020 with several large companies like Alphabet and Sysco issuing sustainability bonds.

This is not just a phenomenon in the U.S., as globally, too, green bonds are on a tear. According to Bloomberg, the issuance of positive impact bonds continues to rise globally; already in 2021, over $794 billion in green, social and sustainability bonds have been issued versus just under $500 billion in all 2020. Issuance continues to increase each year, with YTD 2021 already having 2,095 different positive impact bonds issued versus only 1,362 issued in 2020.

Comparing Green Bonds and Other Impact Bond Categories

What Does the Future Hold?

We continue to see high growth in the social, green and sustainability bonds market, and due to the increasing concern about the environment and mitigating climate change, we anticipate a continued appetite for green bonds.

As the positive impact bond market continues to grow, some investors might have heard the term sustainability-linked bonds (SLB), and they might wonder what role SLBs could play moving forward. Sustainability-linked bonds don’t necessarily use the proceeds for green projects; instead, the coupon of the bond can vary based on whether or not the issuer meets predefined green or social objectives within a predefined timeline. This penalty in higher borrowing costs should motivate the issuer to meet the set targets.

The SLB market is still relatively young and while some issuers have strong environmental, social and governance (ESG) integration and a more progressive business model, other companies may be further behind on their ESG journey. While some investors may prioritize buying bonds from companies that already have high ESG ratings, sustainability-linked bonds that are issued by companies with historically low levels of ESG integration should not be discounted solely due to their poor sustainability performance in the past.

Moving forward, sustainability-linked bonds could be seen as a tool that impact investors can use to incentivize companies that have struggled to address ESG concerns to become more sustainable, increase diversity or implement other green or social initiatives. Our criteria in analyzing SLBs is to make sure that real impact is being delivered, that the stated objectives are not too easily achieved and that the coupon increase is meaningful.

At Praxis Mutual Funds®, we know that there is more than one way that investors can directly impact the world. Strategically buying positive impact bonds is one approach that can drive improvements within issuers. Additionally, we stress the importance of investor engagement as an important tool in encouraging companies to embrace better governance and increased sustainability.

Although shareholder engagement is better known, bondholders can also make an impact by reaching out to issuers and underwriters about important ESG topics—especially when it comes to companies who are more likely to favor traditional solutions. Bondholder engagement allows investors to effectively convey to companies how these issues are important to them and the company’s future.

As positive impact bonds continue to rise in issuance and popularity with investors, it is important to see how these bonds open another avenue for savvy impact investors to make a real difference with their portfolios. By understanding the distinctions between green, social, sustainability and sustainability-linked bonds, investors can and should make intentional choices about how they want their bond purchases to impact the world—be it through underwriting the addition of solar to a utility company, encouraging a company to increase diversity in the board room, supporting affordable housing construction or any number of projects that positive impact bonds back worldwide. Our changing climate demands major structural changes in many areas, and people should realize that their investments can make a difference, too. Green bonds and positive impact bonds are a great way to get started by investing together, impacting the world.

Article by Benjamin Bailey, CFA®, Vice President of Investments, Praxis Mutual Funds.

Benjamin joined Everence in 2000 and was named Co-Portfolio Manager of the Praxis Impact Bond Fund in March 2005, and Co-Manager of the Praxis Genesis Portfolios in June 2013. In 2015, he was named Senior Fixed Income Investment Manager, providing leadership to the fixed income team and oversight to external sub-advisory relationships. Benjamin is a 2000 graduate of Huntington College in business-economics. Connect with Benjamin on LinkedIn.

Disclosures and Additional Information

Consider the fund’s investment objectives, risks, charges and expenses carefully before you invest. The fund’s prospectus and summary prospectus contain this and other information. Call 800-977-2947 or visit praxismutualfunds.com for a prospectus, which you should read carefully before you invest.

Praxis Mutual Funds are advised by Everence Capital Management and distributed through Foreside Financial Services, LLC, member FINRA. Investment products offered are not FDIC insured, may lose value, and have no bank guarantee.

As of Aug. 31, 2021, the Praxis Impact Bond Fund has invested 0.17% of its assets in Enel, 0.39% of its assets in IBRD, 0.32% of its assets in IFC and 0.14% of its assets in Starbucks; the Praxis Growth Index Fund has invested 7.09% of its assets in Alphabet Inc. and 0.34% of its assets in Starbucks; the Praxis Value Index Fund has invested 0.38% of its assets in Starbucks and 0.26% of its assets in Sysco; the International Index Fund has invested 0.36% of its assets in Enel. Fund holdings are subject to change. To obtain holdings as of the most previous quarter, visit praxismutualfunds.com.

Bond funds will tend to experience smaller fluctuations in value than stock funds. However, investors in any bond fund should anticipate fluctuations in price, especially for longer-term issues and in environments of rising interest rates. The Fund’s investment strategy could cause the fund to sell or avoid securities that may subsequently perform well, and the application of ESG screens may cause the fund to lag the performance of its index.

The green bond market, which is anticipated by Climate Bonds Initiative (CBI) to reach $1 trillion annually by 2023, has played an increasingly important role in financing assets needed for the transition to a low-carbon future. In 2021 labelled green bond issuance as a percentage of the total has grown to 20% in Europe and 3% in the US, with green bonds making up approximately half of all labelled bonds ($356.2 billion in YTD issuance) and instruments with other green elements (sustainability and sustainability-linked bonds) comprising more than half of the remainder.¹ Issuers from 47 different countries executed a green debt deal in the first half of 2021 alone.²

The collective focus on green project categories that address climate change mitigation-related issues (such as energy, buildings and transport) has remained strong despite the expansion of the market — likely due to increasing adoption of climate targets at national and organizational levels (Exhibit 1).

This growth, however, has outpaced the development of precise global standards and guidance as to which bonds qualify as “green.” This creates present-day hurdles for issuers and investors, placing further market growth at risk to the extent that trust in the “green bond” label could falter in the context of growing scrutiny over investment funds’ possible greenwashing. Many standard-setting bodies have recently sought to address this issue.

Standardization Aims to Increase Confidence, Credibility

While use of bonds proceeds fairly quickly coalesced around the guidelines laid out in the International Capital Market Association’s (ICMA’s) Green Bond Principles,³ certain corners of green finance continue to grapple with uncertainty. Some issuers remain doubtful as to whether their projects have sufficient impact to qualify in the green financing market. Others fear their perception among ESG investors as a non-green entity may disqualify them from participation.

Some notable guidance has emerged since the beginning of 2020. One key area is “transition” finance, where companies in higher-carbon-emitting industries and businesses look to pursue a greener path. In September 2020, CBI and Credit Suisse published “Financing Credible Transitions,” a framework that defined specific principles for an ambitious climate transition strategy and proposed a set of labels for economic activities along the spectrum from net-zero aligned to stranded to bring clarity to potential entrants to the transition bond market. In December 2020, ICMA released its “Climate Transition Finance Handbook”, which delivered issuer-level recommendations on the disclosure necessary to generate trust from investors regarding transitions, even if it did not provide a definitive framework for defining transition bonds as some had hoped. Broader frameworks like the Transition Pathway Initiative and IEA Net Zero by 2050 Roadmap help to define the credibility of issuer transition strategies and trajectories to date. CBI contributed further to this effort in September 2021 with the publication of a discussion paper on transition finance for transforming companies. This document proposed “hallmarks of a credibly transitioning company” — adoption of Paris-aligned targets, and evidence of robust plans and governance, implementation action, internal monitoring, and transparent reporting — to encourage the disclosure of material and decision-useful information by issuers, and to assist investors in their evaluation of the adequacy of an issuer’s transition.

Investor concerns generally center on whether they have adequate information to make well-informed decisions. Greater formalization of transition benchmarking and green bond qualifications is expected to provide “confidence for investors, credibility for issuers and clarity for bankers.⁴ This, in turn, could promote greater market growth in high-emitting areas of the economy.

EU Taxonomy Advances

The European Union (EU) has established a sustainable activities taxonomy set to underpin the EU Green Bond Standard and serve as a benchmark for a bond’s alignment with six key environmental objectives. The first delegated act on sustainable activities for two of those objectives — climate change mitigation and climate adaptation — was adopted in June 2021, with preliminary recommendations for the remaining four objectives (water, circular economy, pollution prevention & control, and biodiversity & ecosystems) also published earlier this year. The EU taxonomy will provide significant guidance to investors and issuers worldwide on what economic activities may be considered sustainable and the metrics that can be used to make such determinations and may serve as an effective template for other regulatory regimes that seek to provide similar guidance to markets.

China Raises its Standards

China has historically been the only major center of green bond issuance where a significant percentage of green bonds consistently fall short of broadly accepted international standards. However, it has recently made significant headway in raising its green bond qualification standards.

In May 2020, the People’s Bank of China (PBOC), China’s central bank, released a consultation draft of its 2020 Green Bond Catalogue, which removed “clean utilization of fossil fuel” projects from its list of programs eligible to be funded by green bonds. The final draft was published in April 2021, along with a commitment from PBOC Governor Yi Gang to introduce more consistent rules on disclosure. These updates also consolidated standards for issuers across China’s disparate jurisdictions that were previously overseen by several different regulators. The National Development and Reform Commission (China’s state economic planning ministry) and China Securities Regulatory Commission jointly rolled out the new Green Bond Catalogue with the PBOC. This provided a more coherent view on acceptable green projects in the country. Differences remain between these sometimes less-stringent standards and internationally accepted green project categories, such as their allowance for natural gas-fired power generation, indicating some level of dislocation is still likely to persist.

Reporting Needs

Reporting on labeled green bond issuance is one of the more fragmented elements of the market, and it remains a challenge for advisors to reflect the impact of their investments to clients. While most issuers of labeled debt today explicitly commit to reporting on the impact of their securities, this has not always been the case. Moreover, such reporting arrives to investors in a variety of formats with varying levels of granularity, timeliness and disclosures of underlying assumptions.

Third-party efforts such as the ICMA Harmonized Handbook for Impact Reporting and the NPSI Position Paper on Green Bonds Impact Reporting have emerged as best-practices frameworks to enable effective impact reporting.

Investors can accelerate impact metrics development by telling issuers what information they deem most critical and what they regard as market best practices. As engagement with issuers, consultants and banks continues, we expect to see greater market growth and comprehensive green bond standards formalized.

Potential Pitfalls

Although regulatory guidance on the definition of environmentally sustainable investments has been broadly anticipated by the market and is seen as a necessary step, the rapid growth of initiatives risks additional complexity as well. The Future of Sustainable Data Alliance recently published an overview of the various taxonomy projects underway around the world, detailing five regulations already in place, three in draft, 15 under development and two being discussed as a possibility. With notable exceptions, such as the regionally applicable regulations developed by the EU and the ASEAN Taxonomy Board, these regulations are commonly established at the country level, indicating more may yet arise.

As different bodies strive to provide the market with the standardization it is looking for, they risk solidifying differing regional or national definitions of “green” and creating a complex web for issuers, investors and other stakeholders to navigate. Nevertheless, the institution of taxonomies around the globe, so long as they operate on fundamentally similar principles, may provide a much greater benefit in terms of reducing greenwashing concerns. Efforts are already underway to institute “Common Ground” taxonomies, such as the one in development between the EU and China as part of the International Platform on Sustainable Finance (IPSF).

The green bond market is critical to financing the global transition to a more environmentally sustainable society in line with scientific targets. Calvert’s process for evaluating green bonds places a focus on the trajectory and intentionality of issuers in addition to the qualities of financed assets to parse the true impact of green bonds, but even for sophisticated green bond investors, improved disclosure and standardization of green and sustainable bond classifications will help facilitate meaningful investment analysis in addition to promoting broader market growth.

Article by Henry Mason, an ESG senior research associate for Calvert Research and Management; and Brian Ellis, a vice president and portfolio manager for Calvert Research and Management

See their biographies below.

The value of investments may increase or decrease in response to economic and financial events (whether real, expected or perceived) in the U.S. and global markets. Investments in income securities may be affected by changes in the creditworthiness of the issuer and are subject to the risk of nonpayment of principal and interest. The value of debt securities also may decline because of real or perceived concerns about the issuer’s ability to make principal and interest payments. As interest rates rise, the value of certain income investments is likely to decline.

Henry Mason is an ESG senior research associate for Calvert Research and Management, which specializes in responsible and sustainable investing across global capital markets. He is responsible for evaluating sustainable fixed income, as well as supporting environmental, social and governance (ESG) research coverage of the electrical equipment industry. He joined Calvert in 2019.

Henry began his career in the investment management industry in 2019. Before joining Calvert, he was a climate change and sustainability specialist at ICF, a global management consulting firm. Previously, he served as a research fellow at the National Center for Environmental Economics, an office of the EPA, where he conducted quantitative econometric research to support rulemaking.

Henry earned a B.A. as well as an M.E.S. from the University of Pennsylvania.

Brian Ellis is a vice president and portfolio manager for Calvert Research and Management, which specializes in responsible and sustainable investing across global capital markets. He joined Calvert Research and Management in 2016.

Brian began his career in the investment management industry in 2006. He has been affiliated with the Eaton Vance organization since 2016. Before joining the Eaton Vance organization, he was a portfolio manager of fixed-income strategies for Calvert Investments. Previously, he was a software engineer and analyst at Legg Mason Capital Management (now ClearBridge Investments).

Brian earned a B.S. in finance from Salisbury University. He is a CFA charterholder and an FSA credential holder. He is a member of the CFA Institute and the CFA Society of Boston.