SUMMER 2023 NO.75 / THOUGHT LEADERSHIP BRIEF 2 The financial benefits of green bonds continue to be debated; some academics have found that investors are willing to accept a lower yield when investing in green bond versus comparable ‘vanilla’ bonds. Others argue that this greenium (the green premium) is either non-existent, or negligible when considering the additional costs of associated with issuing a green bond. Despite this debate, there is general agreement on the fundamental economic theory that if a greenium were to exist, it would be due to the differential in supply-demand equilibrium between green bonds and that of regular bonds. As financial market regulators and participants work towards greening the financial system, there will be an increasing need to tilt the playing field towards low-carbon investment opportunities throughout the real-economy and built environment. The conversation around green bonds raises multiple questions about the role of governments and institutional investors. Is it their responsibility to promote investments that counteract our collective failure to manage the environment? Should they leverage lower borrowing costs to encourage issuers to incorporate climate change considerations into their infrastructure spending plans? ASSESSMENT If we chose to act on climate change, then we must consider how to create the conditions and environments that encourage and enable institutional investors to use their capital to incentivize the real-economy to invest in infrastructure that operates in a manner aligned with the Paris Agreement objectives. On the other hand, we also need to provide issuers with a straightforward tool for communicating whether and how their infrastructure plans align with those same climate goals. To do this at scale, we need to address concerns about greenwashing. Investors, issuers and other stakeholders throughout the real and financial economy will want to coalesce around standardized definitions of the criteria an investment must fulfil in order to be considered as a suitable piece of infrastructure in the low-carbon future. Classification systems (i.e. taxonomies) can be designed to help determine whether an economic activity or asset can be considered green, and simplify the process through which public and private sector issuers can report on their efforts to improve the environmental performance of their operations. When specifically applied to climate change mitigation, this can be accomplished by defining the acceptable emissions intensity an economic activity must achieve in order to be considered as performing in a manner consistent with a country’s contribution to the Paris Agreement objectives. By providing this common-language which acts as a standardized reference point to measure the sustainability performance of economic assets, we can help to improve transparency and reduce greenwashing. If investors want to credibly show that they are ‘greening’ their portfolios, they will need to show that the companies and projects that they invest in, are aligned with such performance requirements. Imagine, for example, that a Mandatory Provident Fund (MPF) provider wants to market a fund as ‘green’ or ‘climate-aligned’ and state that this fund contributes to Hong Kong’s climate change objectives. Reporting on the climate-related performance of this portfolio would require some form of standardized classification system – taking the data about the greenhouse gas emissions of an economic asset or activity, and providing that material in a manner that can be used by asset managers to inform what types of bonds might be eligible within the fund’s investment universe, or to show how much of the fund is invested in green projects at any point in time. But the question of who regulates the labeling of climate change mitigating actions and the role of science remains. Since the early days of the green bond market, organizations such as the International Capital Markets Association (ICMA) and the Climate Bonds Initiative (CBI) have played a central role in standardizing the definitions and practices for reporting what can be considered sustainable. As the market continues to grow, there is growing acceptance that a regulated definition of what contributes to climate change mitigation is required if the market is to continue growing.
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