Can we prove that the shoe industry is not conducive (‘additional’) to walking by showing that infants start walking without shoes, and would have done so whether there were shoes or not? In the same way, can we prove that green bonds do nothing to advance climate-friendly investment?
Yes, claims a new paper from NBER* that has been widely circulated by armchair critics who seem to believe all investor efforts to mitigate planetary deterioration are hopelessly ineffective.†
To be more exact, the NBER paper claims to prove that green bonds have no ‘additionality’ by showing that most green projects would have been initiated regardless of the involvement of green bond structures. In other words, green bonds aren’t financing new green projects, they are merely refinancing those already underway.
Now it would be nonsense to criticise the shoe industry for providing shoes to people who have already learned to walk. Similarly, it is misguided to denigrate the green bond market for supplying finance to existing green projects. Yet this is the argument the NBER paper is making.
Their critique is based on a fundamental misunderstanding of the role of bonds in the financial system. I love bonds and have been known to utter things like “nobody puts fixed income in a corner.” But I understand their place in the financing ecosystem, as it was taught to me as a blue-eyed quant associate at Barclays Capital once upon a time: bonds are the cheapest form of finance for large-scale capital needs. Because of this, the bond market is a place that large corporates try to access as soon as possible.
However, it usually takes quite some time before a new project can tap this market for financing. Why? Because new projects are complicated and messy, and bonds are supposed to be simple and standardised. A company embarking on a new project will usually first nurture it with internal and external equity, raise mezzanine and bank loan financing to help it grow, and only once it matures be able to replace these expensive sources of capital with cheap bond finance.
In short, bonds are instruments for replacing more expensive sources of capital for already-existing ventures. Step 1: develop a project with expensive capital. Step 2: refinance using cheap bonds. Rinse. Repeat.
From a markets perspective, there is an ongoing discussion about “greeniums” (i.e. the lower rate of interest green bonds pay vis-à-vis vanilla bonds). Most estimates place the greenium at around 0-0.1% (0-10 basis points). As I said, I love bonds, but I don’t pretend to believe that a 0.05% difference in debt financing costs will derail the development of, say, a renewable energy project (unless it is insanely leveraged).
So why is that green bond critics pretend to believe that tiny greeniums are make-or-break for projects that – let’s be clear – are projected to produce double digit internal rates of return?
Maybe their complaints have more to do with all that (irritating) green bond marketing, which often trumpets ‘additionality’ even when it is limited (or non-existent)?
Well, this may be a surprise to some, but sales pitches regularly exaggerate the benefits of a product. Nike’s “Why Walk When You Can Fly” marketing of Air Jordans does not mean that the shoes empower the wearer to defy gravity – and no-one believes this to be the case, either. What the shoes actually do is help the wearer jump a little higher.
Similarly, a green bond enhances the financing of climate-friendly activities. Shoes make walking easier, and more pleasant, therefore encouraging the activity. Green bonds make refinancing green projects cheaper, therefore encouraging companies to initiate more of them.
This is the key point I am trying to get across, one which some of the ‘concerned voices’ seem to miss entirely. I have a few other bugbears with these types of analyses: the use of oversampled cross-section time-series data, using US muni markets as proxy for global green bond markets, and the failure to discuss the one, true greenium sitting in the green Bund, but we will leave that for another day.
*National Bureau of Economic Research, "Green Bonds: New Label, Same Projects", Sep 2024.
†“Green bonds are bunkum”, Financial Times Alphaville, 16 Sep 2024.
