Varma has invested in green bonds since the first half of this year. Responsible investment principles – and of course practices – permeate Varma’s entire investment portfolio, so the time was ripe to learn more about the much-talked-about green bonds.
The debt capital raised through the issuance of a green bond is, in effect, earmarked for environmentally friendly investments. The borrower commits to keeping the debt capital raised through the green bond separate from their other assets and to report annually on the types of green projects the debt capital has been used for. In most cases, an independent expert will issue a statement on the green bond framework of issuer. Green projects typically concern, for example, the use of renewable energy, low-emissions transport projects, energy efficiency, or waste processing that is in line with the principles of sustainable development. Green bonds have the same position of seniority as the issuer’s other debt capital, so, from a credit risk perspective, green bonds are no different from regular bonds.
From the issuer’s perspective, green bonds may be attractive, for example, in terms of expanding the investor base. Through green bonds, issuers can draw attention to their corporate responsibility agenda on a more general level or they can highlight the environmental friendliness of their operations, which could in turn attract, for instance, responsible equity investors to the company. Green bond investors, for their part, have greater insight into how their debt capital is being used in a company, as the borrower reports on the use of the funds in considerable detail. The investor can fund green projects without assuming extra risk from the project being carried out, as the borrower assumes responsibility for the loan with its full balance sheet.
The green bond market has grown strongly in recent years, which may be partly due to the growing popularity of responsible investment worldwide. The credit rating agency Moody’s expects the market issuances to possibly even double this year compared to 2016. Growth was just as strong already last year, so the development has been very fast. Nevertheless, the size of the green bond market is only roughly one per cent the size of the entire bond market.
From an investment perspective, there is an important difference between equity- and loan-type investments. We believe, in principle, that responsible companies will have greater potential to achieve future success than average. If that holds true, the investment will essentially benefit the company’s shareholders. The lender’s compensation is limited to the annual interest rate, which, in the case of green bonds, may in part be slightly lower than the interest rate on regular bonds, due to the extra reporting costs incurred by the companies. Time will tell whether it is worth it, from a responsibility perspective, for the bond investor to accept the possibly slightly lower return level of green bonds. Green bonds will, however, be a part of the big picture of responsible investment in the future, and by being a part of this market we can also learn and develop our own expertise in even broader responsibility issues. For now, there is a limited number of green bond issuers, which poses its own challenges in terms of building and diversifying a portfolio.
Currently, the benefits of responsible business have been more unequivocal in equity investments. Since responsibility is integrated into all our investment decisions, we want to build so-called responsibility portfolios on more than just a single segment of the investment portfolio, i.e. equities. Who knows, maybe one day there will be companies whose debt capital acquisition leans solely on green bonds. We are following the development of this rising market with great interest. When this blog entry was written, our green bond portfolio was valued at approximately EUR 250 million euros, representing some 3% of our liquid bond portfolio.
Petri Ala-Härkönen
Director, FICC