G20 Green Finance Study Group: Green Bonds Certification Shades of Green and Environmental Risks 2016

Green bonds are bonds whose proceeds are invested in an environmentally friendly way. Investors in this asset class require various kinds of information. First, they need to know which bonds are in fact ”green”. Because most investors find it too costly to verify and assess for themselves the environmental impact of the use of proceeds, the emergence of coherent, publicly available standards can help to broaden the investor base. Amidst rapid growth in the market, there are still many different definitions and labels for green bonds (green bond principles, climate bond standards, national definitions such as the green bonds endorsed catalogue in China), as well as many different instruments to certify “greenness” (“second opinions”, green ratings, green bond indices). These certification schemes differ across a number of dimensions including their degree of granularity, the availability of ex post monitoring, and the use of quantitative tools.

Second, investors building green portfolios require information for grasping the range of investment opportunities and managing the associated financial risks. The performance of green bonds and related indices should be assessed using both the level and volatility of returns and against appropriate benchmarks. But if limiting exposure to environmental risks is an objective of green bond investors, conventional financial return and risk metrics alone are not sufficient.

The rest of this note proceeds as follows. After a brief review of the composition of green bond issuance, the next section examines and classifies the various instruments provided by the private sector to certify green bond issuance. Are existing schemes appropriate and informative for long-term and other investors, and are there aspects that could potentially be improved? The following section focuses on the financial risks associated with green bonds. In their short history, the return performance of green bond indices has been good relative to comparable bond indices, though only when foreign exchange movements have been hedged; currency movements have substantially reduced the performance of green bond indices otherwise. However, it is not the case that investors in all green bonds are shielded from environmentally related credit risks. Could investors benefit from there being a clearer distinction made between greenness and exposure to environmental risks?There is a summary of policy implications in the final section.

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