Climate change adaptation (moving towards net zero by shifting to renewable energy and changing behaviors so that we produce fewer greenhouse gas emissions) and mitigation (building resilience in the face of the impacts of climate change) are expensive, and must be paid for somehow. Policy-makers accept that climate change mitigation and adaptation require co-operation between public authorities and private business, and a combination of public and private finance. Green bonds promise to be a component of addressing this need for financing, as well as the interests of investors who want to invest in sustainability. But do they really do this? The urgency of the need to address climate change, together with our reliance on private finance as an important part of the proposed solution, means that this is a really important question. In order to address climate change, green bonds should finance green or sustainable activities, and, preferably, activities that would not otherwise be funded.
In Green Bonds, Empty Promises, Quinn Curtis, Mark C. Weidemaier, and Mitu Gulati present the results of their study of a dataset of green bonds issued between 2012 and 2022 and of interviews with market participants. The authors say that in credible green bonds they would expect to see mechanisms to increase the cost of non-compliance, but, instead, they find “a concerning lack of enforceable promises” (P. 56.) They find some language of commitment in more than half of the bonds in the dataset, although they state that, for varying reasons, they are likely to be overstating the extent to which issuers make firm green commitments (e.g. pp. 17,19). But even where green promises are made, they are not backed up by the usual enforcement mechanisms: none of the bonds in the sample “expressly makes it an event of default for the issuer to fail to live up to its green promises.”(P. 24.) In addition, the authors find that green bonds are evolving away from enforceability over time, now including disclaimers excluding a failure to comply with green promises from the application of a catch-all events of default provision and disclaimers of any duty to pursue green objectives.
The authors find the lack of legal enforceability of green promises in green bonds to be something of a puzzle. Although some of the market participants they interviewed suggested that the market worked on the basis of reputation rather than on legal enforceability, they prefer an explanation that focuses on the incentives of issuers and investors. ESG funds can use holdings of green bonds to demonstrate their credibility, but “investors in green funds are almost certainly not sensitive to whether the underlying bonds in ESG funds’ portfolios are backed by strong legal enforcement.” (P. 45.) On the other hand fund investors do care about performance, and enforceable green promises would likely lead to lower returns on the green bonds (the “greenium” ). The authors emphasize that they are not arguing that issuers are failing to meet their green promises, rather that they are not legally bound to meet them. Green bonds are not necessarily tools for greenwashing, but they could be.
Certification schemes for green bonds do not currently focus on enforceability of green promises, and the authors suggest that one way to address this issue would be to change this. The regulatory focus in the EU and the US on characteristics of funds that market themselves as green or ESG funds is another development that could address enforceability of green promises. The recently agreed EU Green Bond standard, a voluntary standard, adopts a different, regulatory, approach which focuses on ensuring that proceeds of a green bond are in fact allocated to environmentally sustainable activities as defined in the EU taxonomy, imposing regulatory requirements on issuers and on external reviewers, backed by sanctions. But it is not clear whether green bond issuers will choose to opt into this regime.
Green Bonds, Empty Promises is a useful resource for information about how green bond documentation is constructed and drafted. In arguing that end investors want to be investing in ESG products, but probably also want the returns associated with non-ESG bonds, the authors bring us back to the question whether we really can rely on finance to address climate change. And, in thinking about this question it is really useful to be reminded to think about climate finance as involving more than defining what is and is not green or sustainable, but to think about the details of the documents involved in market transactions.
