For the first time, researchers have examined what potential investors want from the United States clean energy bond market. The December 2014 report “What Investors Want: How to Scale-Up Demand for U.S. Clean Energy and Green Bonds” shows investors’ tastes vary widely. Offering a broad menu of options is the best response, the authors recommend.
What is currently on the menu is not necessarily what investors want. The authors, a team from Clean Energy Group (CEG) and Croatan Institute, describe a disturbing disconnect between the types of bonds that are in demand and the types that are available. This disconnect may be holding back the growth of the domestic market.
“There’s a huge mismatch between investor demand and credit supply,” said Joshua Humphreys, president and senior fellow at Croatan Institute, during a webinar on Jan. 14. “You’ve got massive oversubscriptions of what exists. There’s demand that’s not being met. Clearly, there is a hunger for much-diversified forms of issuance at a lower credit quality.”
“These bonds need to become plain vanilla,” said Robert Sanders, senior finance director at CEG. Offering relatively simple ‘vanilla’ securities is preferable to offering unusual options.
Clean energy bonds are a subset of the green bond market. They are also a subset of the climate finance bond market. Green bonds may address a wide variety of environmental issues; building a sustainably constructed shopping mall might be considered ‘green.’ Similarly, climate finance can address a broad range of concerns beyond clean energy.
“We would like to see the green bond space get more serious about funding climate solutions and funding clean energy in particular,” Humphreys said.
“There’s a growing group of foundations that’s committed to both divesting from fossil fuels and investing in climate securities,” Sanders said. “In the past, the reinvestment part of that has focused on cleantech private equity and venture capital.”
The report does not include an estimate of the size of the United States clean energy bond market. But it does provide many in-depth recommendations for action and research.
Different Flavors Appeal to Different Investors
The researchers interviewed bond buyers, asset managers and investment consultants, foundation endowment representatives, faith-based investors, investment bank representatives, decision makers working for corporations and insurers, and staff of public pension funds. They also held an invitation-only discussion in New York City in September 2014.
The recommendations these groups provided varied widely. Based on the report, there appear to be no points upon which all of the stakeholders agreed.
However, across the board, it was clear that a greater variety of clean energy bonds are needed to fill the existing demand in the market. Some investors expressed interest in junk bonds. In contrast, others seek highly rated investments.
“Conventional and mainstream investment managers and investment consultants have a preference for high-quality green bonds,” Sanders said. “Securities for these investors will generally require a credit rating or strong credit enhancement.”
Creating a broader menu of choices might include offering bonds of a variety of credit quality levels, durations, deal sizes and yields. Providing more taxable bonds can appeal to investors who are not interested in tax-exempt ones.
Bundling small deals into larger ones could be an especially productive route to offer improved purchase options to investors. On the other hand, some smaller investors are not able to participate in larger purchases.
“Big banks are focused on larger deals and less on municipal project bonds,” Sanders said. “Insurers seek investments across all fixed income markets, across the whole credit spectrum. Many of the largest corporations have bought green bonds.”
Faith-based investors said adding social responsibility criteria would make bonds more appealing to them. Green bonds funding clean energy for low-income housing, nonprofits, or community organizations might attract this group of investors.
Sanders said faith-based investors are also comfortable with lower-grade, small and unrated bond issuances.
Many investors said financial performance was their primary motivation and that green criteria were of secondary performance.
In contrast, socially responsible investors and impact investors took a stronger interest in the sustainability goals of financing and would sometimes even investigate individual offerings themselves without relying on green bond labels.
The researchers found some investors consider liquidity – the ability to move funds – to be the highest-priority consideration they face. Many investors need to be able to price funds and/or redeem them daily. Purchasing larger deals is one strategy they find helpful.
Investors expressed a diversity of credit rating preferences. Some wanted to see a broad range of offerings from unrated to AAA-rated bonds. Certain investors seek specific brackets on this continuum.
Labeling May Whet Investors’ Appetites
The report found investors have a variety of perspectives on the value of labeling. Some investors may miss opportunities to invest in clean energy bonds if they are not labeled as ‘green.’ This is particularly true in the municipal bond and corporate asset-backed securities markets.
Other investors highly familiar with the industry may not pay much attention to whether a bond is labeled as green and may instead look at the purpose of the financing.
A group of financial institutions has developed a set of Green Bond Principles. These provide voluntary labeling guidelines for green bonds. However, not all clean energy bonds in the United States are labeled this way.
“We think these principles are very helpful,” Sanders said.
The report recommends labeling all clean energy bonds as ‘green.’ However, it also cautions that sustainability is a matter of degree – different projects have different environmental benefits and costs. Also, some companies issuing green bonds may also be involved in environmentally costly activities at the same time.
As both Reuters and Yale Environment 360 have noted, the potential for greenwashing is substantial in the absence of clear communication about what green bonds are and are not.
Standard & Poor’s and MSCI are constructing green bond indices, Humphreys said. There is extensive discussion taking place about the development of a green bond asset class.
Transparency Can Reveal the Ingredients of Bonds
Lack of transparency about where green bond funding goes can be a stumbling block for the industry. It can also create public relations problems for green bonds as a whole. Some investors filter out bonds that lack transparency. Many investors seek disclosure, third-party audits, and ongoing reporting of the sustainability of green bonds. Others are not as selective. And some will even research the results on their own.
Bonds offered by the World Bank have been controversial in this regard. Some investors view all bonds from the World Bank, African Development Bank, and the International Finance Corporation as intrinsically ‘green’ and socially responsible because they are assisting emerging economies and disaster recovery projects. Others question the transparency the World Bank offers.
The authors recommend that any organization seeking to standardize green bonds in the United States should require that companies report how the proceeds are used.
“Socially responsible investors are more concerned with the use of proceeds than with whether they are labeled green or not,” Sanders said. “Their managers expect equal financial performance from green bonds as they do from other bonds they hold.”
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