The Pitfalls of ESG Bonds
The ideas of ESG have certainly enamoured the world today, as it becomes a ubiquitous topic heralded as a game-changer. The pandemic has certainly led to an increase in sustainability-linked products. Once seen as the realm of tree-hugging environmentalists, this area has now attracted many of the bigger players, as investors understand that there is a double bottom line that can be achieved here, combining attractive financial returns with robust social returns as well. Over the course of the pandemic, ESG has certainly performed well. The sustainability bonds market is expected to reach a trillion dollars by the end of the year, Asset management firms like BlackRock and Vanguard, the two largest ETF providers, now offer clients a choice of ESG related funds. The sustainable stock exchange initiative has seen more publicly-traded companies being trained on ESG topics, covered by an ESG index, and in some cases even mandating ESG listing.
As they grow in prominence, investors, and perhaps, more importantly, regulators, are identifying thorny issues with green or sustainability linked bonds, despite being ostensibly fault-free. One major issue revolves around scepticism of the provenance of their issuance. For example, the validity of green bonds issued by countries boasting questionable human rights records is being questioned. Countries like Belarus, Russia, and China have all been big issuers of bonds supposedly adhering to ESG principles, but whether they should be bought has been up in contention among money managers around the world. At Mirova, a French fixed-income portfolio manager, the distinction between countries has taken an even more subjective twist, where countries adjudged to be capable of democratic change being considered acceptable issuers of green debt. When it comes to China, consequently, ‘even if the green bond is purely perfect, [they] will not accept it’.
Arbitrary and overly flexible standards for green bonds is a prevailing obstacle, that stem from a larger problem of a lack of standardisation that exists in the market. If green or sustainability linked bonds are too loosely defined, there remain fears amongst investors that their money might not be anticipated or desired. On top of this, inconsistencies in definitions can lead to market issues as well. For example, clean coal was included as a permissible use of green funds in China, something that was explicitly banned in the EU.
Greenwashing is another concern that investors and regulators alike have about the growth of the market, stemming once again from questions about how robust the standards currently set are for measuring sustainability. Firms set up KPIs that are irrelevant to their business models, or in some cases ‘account for a tiny portion of their CO2 emissions. With hardly a challenge in achieving these goals, and minimal if not non-existent consequences for failing to meet them, this has been a clear example of the ESG movement being abused.
A good example of this would be Teva, an Israeli-American pharmaceuticals company that sold a 5 billion dollar sustainability linked bond, but drew immense criticism. The targets included improving access to healthcare and medicine in lower-income countries, as well as reducing emissions. There were problems with both of these. The criteria for the former was to do with regulatory submissions to the WHO, rather than approvals. The targets that were set for the latter, on the other hand, were scarcely ambitious considering their existing trajectories.
It is not difficult to see why there exists a cynical opinion of such tools, despite their growing maturity and promise in the markets. Several of the issues for these products stem from a singular problem: a lack of standardization. This spans across definitions from the very beginning of the cycle to impact reporting at the end. Gone are the days when non-profits could purchase pictures of malnourished children and claim they fed them a certain number of meals or a certain amount of water. Investors demand much more robustness today, with quantifiable figures on how their investments made a difference. The market, however, is still young, and as long as it isn’t used as a tool for greenwashing, it certainly holds much promise for addressing several issues moving forward.