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Green bonds are bond issuances aimed at financing a project or activity with an environmental benefit. They have the potential to contribute to funding a more sustainable economy in a very concrete way. But how can they be integrated into an investment strategy effectively? And how can we ensure the impact of the financed projects?Thomas Coudert, Head of Sustainability for Core Investments at AXA IM, has had the opportunity to discuss all aspects of green bond management and shares his expert insights on the subject.
Green bonds are financial instruments that channel capital towards new or existing projects with positive environmental characteristics. A green bond can be issued by a corporation, an international organisation, or a local government and can cover a wide range of projects, such as low-carbon transportation, energy efficiency in buildings, renewable energies, etc.
The green bond market has seen exponential growth since 2007 with the issuance of the first green bond by the European Investment Bank and the World Bank. The Climate Bonds Initiative (CBI) estimates the value of green bonds issued between January and November 2024 at over $600 billion, and green bonds represent 12% of the global bond market according to the International Capital Market Association's (ICMA) quarterly report. According to the same report, Europe remains the leader in environmental bonds, with 52% of the total value of green bonds coming from European issuers. It is followed by supranational institutions, which account for 18% of the titles, Asia (17%) and North America (10%).
However, new countries are adopting this type of bond, and the profile of green bond issuers is gradually diversifying. Thomas Coudert explains: "Over the past ten years, the green bond market has experienced exceptional growth, marked by a high level of issuer diversification and increased liquidity. This diversification is well received by investors as it allows them to better spread the risk of their portfolios, maintain a connection with the real economy while financing the transition."
Green bonds undoubtedly have a role to play in the development of green projects. However, Thomas Coudert points out some limitations to the development of green bonds: "Some economic players do not have the size and quantity of green projects to finance a benchmark issue of 500 to 1,000 million euros. Alternative financing solutions must be found to support their transformation.
Despite these challenges, the outlook remains very positive. Thomas Coudert concludes: "The market should continue to grow, with new players and the development of regulations."
With the exception of the European Union's "European Green Bond Standard," which is expected to come into effect on 21 December 2024, there is no specific regulatory text dedicated to the issuance of green bonds. The market has thus largely structured itself around the ICMA's "Green Bond Principles" (GBP) and the CBI's "Climate Bonds Standard and Certification Scheme."
The ICMA has particularly contributed to establishing a definition of green bonds by developing the GBP. This document defines four essential criteria for the categorisation of a green bond:
The allocation of funds towards "green" projects is the cornerstone of the Green Bond Principles and is what makes green bonds special. This involves directing the funds raised by the bond issuance towards eligible green projects – i.e., projects that can lead to clear environmental benefits. Among the 10 categories of eligible green projects defined by the ICMA, we find renewable energies, pollution prevention and control, and buildings aligned with regional, national, or international environmental performance standards.
In the market, alignment with current standards allows companies to enhance their image, improve their access to financing, and potentially benefit from a lower cost of capital. However, issuing a green bond represents an additional cost for issuers who must produce a variety of documents (Green Bond Framework, annual reports, ex-ante and ex-post reports, etc.) and ensure that the issuance is aligned with standards through an external audit.
In addition to the Green Bond Principles, we are now seeing the development of national or regional normative texts designed to frame green bond issuances. Most of these texts are built on the four criteria of the ICMA's GBP, which are a reference in the bond market: this is notably the case of the CBI Standard, which details each of the criteria defined by the ICMA with precision based on a Climate Bonds Taxonomy, but also of the ASEAN's "Green Bond Standard," the Indian SEBI's "Green Debt Security," or the Japanese "Green Bond Guidelines." These various standards adapt the list of eligible green project categories to their local context. Their categories are often very close to those of the ICMA, but they include differences on certain criteria.
Only the EUGBS stands out from the standard landscape due to its rigorous framing of the nature of the financed projects, on the one hand, and the use of transparency documents and standardised indicators, on the other hand. Thus, to comply with this framework, at least 85% of the funds must be allocated to assets, CAPEX, or OPEX aligned with the European Taxonomy. The remaining 15% corresponds to projects or assets eligible for the Taxonomy but for which the technical selection criteria are not yet published. This point of divergence can have significant consequences on the titles, since the European Taxonomy is a very demanding analysis framework and is based on very political arbitrations - particularly on issues such as gas, nuclear, or aviation.
The level of requirement was even higher in the first proposal of the EUGBS: originally, the standard was to be mandatory, and the documentation had to include an annual alignment plan to the Taxonomy. This proposal was criticised by the ICMA, which wrote that "[as it stands] only European organisations that might feel obliged to comply with this standard would dedicate the necessary resources to obtain it". The Association added that, given the constraints, other issuers might change their source of financing or access sustainable finance in other jurisdictions. To keep the EUGBS an accessible standard, this proposal was modified. The first voluntary European green bonds are therefore expected very soon, particularly from banks and utility services.
As each standard incorporates its own definition of a green project, it is possible to observe differences in the scope of projects financed by green bonds. This observation represents a first point of attention for investors.
Eligible green projects are not identical from one standard to another: they are based on different underlying taxonomies with their own methodologies for examining eligible activities.
The reprocessing of certifications by data providers is a second point of attention. Indeed, the standards in force serve as a basis for the classification and grouping of titles by different data providers or public organisations. In these databases, obligations are qualified as green bonds according to the standards with which they declare to be aligned and/or based on the analysis of the underlying data provider. The scope of integrated green bonds can thus be expanded or reduced beyond the certified titles.
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The methodologies for processing and categorising titles are heterogeneous: some bonds may be qualified as "green" by some organisations but excluded from other data sets.
Given the diversity of standards, titles, and issuers, a qualitative and quantitative analysis of each green bond has become essential for investors.
Thomas Coudert explains that AXA IM has developed a proprietary analysis framework that not only focuses on the environmental benefit of the financed projects but also on the ESG strategy of the issuer to detect "opportunistic" emissions and prevent the risk of greenwashing. He adds: "It is necessary to analyse the issuer to ensure its ESG strategy and to confirm that the issuance is indeed consistent with its greenhouse gas emission reduction trajectory. This analysis could, for example, filter out an economic player without a strategy for exiting fossil fuels and issuing a bond to finance solar panels for a small percentage of its turnover."
The study of the nature and impacts of the projects financed by the bond adds a second layer of verification to this analysis. Lastly, the issuer's commitment to directing the allocation of funds and regularly reporting on the progress of its projects can be an additional selection filter. This commitment allows the investor to obtain relevant numerical information throughout the holding period and thus better steer its investment strategy, follow the evolution of the project's impact, and gather the necessary data for its reporting with greater ease.
The green bond market is now mature, and we are seeing a standardisation of projects and the impact indicators associated with them. However, green bonds are now facing the challenges of financing the transition since they only take into account projects and companies that are already advanced in their transition and exclude "non-green" projects and issuers that aspire to this ambition. This limitation poses a major challenge: how to finance the transition of sectors and companies that need it most? Thomas Coudert emphasises the importance of broadening the perspective: "To finance the transition of states and companies, it is necessary to consider other types of instruments." With the growing environmental urgency, the question arises of transitioning companies towards a more sustainable model.
The current standards do not allow funds to be directed towards so-called "enabling" projects, as their goal is to identify sustainable projects. For example, the European Taxonomy partially takes into account transition activities through the categories of "enabling" and "transitional" activities. However, the EUGBS requires full alignment with the Taxonomy of the financed activities, which automatically excludes these transition activities. Moreover, some economic activities may contribute to the environmental transition without being covered by the Taxonomy.
Financial institutions, therefore, have no tools or indicators to identify credible transition projects without exposing themselves to the risk of greenwashing.
Thomas Coudert thus specifies that, for all these reasons, financial institutions wish to see the development of a regulatory framework more oriented towards transition. "To finance the transition - this is called 'closing the financial gap' - it is necessary to go beyond funding projects that are already green. It is therefore necessary to develop a regulation that includes instruments that finance the transition while remaining vigilant about the risk of greenwashing."
The emergence of working groups on this subject illustrates this wish: the ICMA notably published last June a "Green Enabling Projects Guidance document" allowing the issue of transition to be addressed by defining "Green-Enabling Projects".
The challenge now is to accompany this regulatory evolution with tools that enable financial institutions to identify and effectively assess transition projects, beyond the current simple eligibility criteria.
