With major companies across a variety of sectors signing on for the net zero 2050 initiative, it’s no surprise that environmental, social and governance vehicles are taking over the investment landscape. The recent report from the Intergovernmental Panel on Climate Change—which concluded that we can expect a continued rise in global temperatures, and as a result we should expect an increase in wildfires, floods, heat waves and water shortages in the next 30 years—will likely accelerate the push by companies and investors alike toward net zero emissions.
And while ESG funds have been a reigning winner—both from a return perspective as well as a social perspective—in recent years, interest is increasing in green bond financing within the $46 trillion U.S. bond market.
The fixed income market is approximately $120 trillion globally—and green bonds are the fastest growing area in the fixed income markets. Today’s green bond market, however, is only the start. If you think about it like a baseball game, we’re only in the second inning—and the green bond market, along with ESG as a whole, have a long way to go.
ESG Investments Flood The Bond Market…
Green bonds sit under the umbrella of sustainability fixed income, also known as ethical debt, green finance or ESG finance. There are different types of bonds within this space—green bonds, which are project exclusive and tie to environmental concerns; social bonds that are tied to projects that benefit society; and sustainability bonds, which require the invested money to be used for environmental and social purposes.
These products are gaining traction as a result of overall focus on ESG from investors of all generations. In terms of actual numbers, on the investment front, data from Morningstar shows that investors poured $54 billion into bond funds specializing in ESG issues in just the first five months of this year, compared to almost $68 billion for all of 2020. In terms of green bond issuances, according to data from the Climate Bonds Initiative, $150 billion of green bonds have already been issued as of the end of May 2021. This surge in green bonds builds on a record year in 2020, which saw $178 billion worth of green bonds added in the second half, almost double the $91.6 billion added in the first half of the year.
Finally, the overall assets under management (AUM) in ESG bond funds have tripled over the last three years, even as latest figures show a 14% rise in AUM to $374 billion between January and May. While other investments have been muted and the AUM of the entire fixed-income fund universe rose only 12% in 2020, that of ESG bond funds surged by as much as 66%.
…But Greenwashing Concerns Remain
In the U.S., the ESG market is still widely unregulated. While there are recommendations and frameworks—and the SEC has announced its intent to scrutinize the sector more closely—there currently are no disclosure requirements to help eliminate greenwashing. Greenwashing refers to the possibility that certain bond funds—or any type of fund, for that matter—may not be as sustainable as they claim, or that fund managers are finding it difficult to demonstrate the ESG value-add of such funds.
While the U.K. has its Sustainable Finance Disclosure Regulation (SFDR), here in the States, we are still grappling with the concept of ESG and requirements for the green bond and sustainable asset class space. In order to truly understand whether a bond is actually green, investors must look beyond self-reported statistics from companies, which isn’t always the easiest thing to do. There is an entire industry that’s currently in development to help with verification of green bonds and ESG, but there is not anything similar to what they have in Europe with SFDR. Currently, it’s up to investors, regulators and issuers alike to call out greenwashing in the sector—which ultimately threatens to limit or altogether derail the progress promised by green bonds and sustainable investing in the first place. Lack of regulatory structure, as well as lack of verification standards, means that while investments are pouring into the green bond space by hopeful and socially conscious investors, that money may not be making the impact one would hope.