Who decides what is ‘green’ enough to be ‘green’?

By Stephanie Garcidueñas Nieto #

As the preferred ‘green’ financial instrument to fund the green transition, Green Bonds (GB) have become leaders of the market, with S&P Global forecasting a 1$ trillion issuance for 2023 alone. Nonetheless, the green bond market continues to face criticism about greenwashing, lack of a common green definition for projects, transparency, and metrics to define what is ‘green’. Hence, there are key questions to ask about the way in which a bond becomes ‘green’, such as how a bond obtains its green label or certification and who can wield the power to assert the qualifying title.

In simple terms, Green Bonds are a debt promise by the issuer that has to be repaid with a premium with the novelty of them being used solely for environmentally sound projects. This raises the key concern of how to assure that the green label portrayed by said bonds is environmentally accurate. In principle, green bonds are debt instruments similar to vanilla bonds. This means that they are based on a debtor-creditor relationship, that the principal will yearn for interests to be paid over a (usually) long timeframe, and that the content of the financial obligations (e.g. rate of repayment, the currency of issuance, etc.) will depend on the financial profile of the issuer, the market of destination, etc.

On top of that, green bonds require the funds obtained from them to go towards green/sustainable infrastructure, which adds some extra steps to obtain said ‘green’ label.

What exactly is “green”?

Several problems arise with the definition of “green”. A few years after the first issuance of green bonds, some private taxonomies were created in order to try and standardize the market: a move that was justified as a response to the rapid multiplication of standards and the possibility of watering down the requirements, but  has also led to the creation of some gatekeepers in the sector. Originally these taxonomies followed the Green Bond Principles issued by the International Capital Market Association (ICMA) and afterwards the Climate Bond Standard issued by the Climate Bonds Initiative (CBI). Further on, some other institutions (i.e. CICERO Shades of Green) and countries developed their own standards or taxonomies on what ‘green’ infrastructure is and can, therefore, be funded by a green bond. However, these taxonomies are still following the recommendations made by the Green Bond Principles set by ICMA.

Once the terms of reference have been decided, the debtor who wants to issue a green bond should usually follow a three-prong procedure: pre-issuance, issuance, and post-issuance. The pre-issuance phase is particularly crucial because it sets up the green qualification of the bond by including documentation on preparation of the bond; use of proceeds; process for project evaluation and selection; management of proceeds; and reporting. However, it is important to note that even with established steps to follow, green bonds still have the potential to further greenwashing by creating inadequate metrics, avoiding transparency and reporting of their project teams and management, and embezzling the funds raised towards other not-so-green projects on the side.

In addition to the steps above, there are two extra procedures to take into account: one is a Green Bond Framework (GBF) which is a guide that can be national or by region and aims to uniform the bond’s structure by making explicit how the money from the bond is going to be used. In theory, GBF should act as a standard with normative universal rules, however, problems arising with it is the disparity in application throughout geographies, meaning some countries have to undergo extra and more stringent checks of their projects. The second is external reviewing. Here, it is important to notice that while external reviewing can be requested as part of the GBF in post-issuance to continue the monitoring of the bond, it is not a mandatory part of all of the GBF.

External Reviewers are independent entities validating the green bond issuers’ claim of sustainability. Even though the external reviewing of a bond is still an optional measure in most frameworks – with the exception of CBI’s Climate Bonds Standard – they are highly valued by investors, and most green bonds comply with the reviewing which increases the validity of the green claim. Consequently, external reviewers end up playing a major role in the green bond world. Once an issuer decides to have an external reviewer for their green bond, four review options are available: Verification, SPO, Rating and Certification.

Is external reviewing as independent as it seems?

External review types
VerificationVerification refers to the assurance of an internal tracking method for the use of proceeds, a statement of environmental impact, or alignment of reporting with the GBP’s (e.g. Agusto&Co, GFC, Arup).
Second Party OpinionSPOs include an assessment of the issuer’s policy and/or process relating to environmental sustainability (e.g. CICERO, Sustainalytics, Vigeo Eiris. Deloitte).
Green Bond Scoring/RatingGreen bond scorings or ratings are based on an established scoring/rating methodology evaluated by qualified third parties (e.g. S&P, Moody’s, ISS).
CertificationCertification refers to a green bond, a green bond framework, or the use of proceeds to be certified against a recognized external green standard or label by accredited third parties (e.g. CBI).
Source: Author’s own elaboration with data from ICMA2018.

Despite the different options, this does not mean that the operations can be undertaken by multiple actors. Nevertheless, certification adds a layer of legitimacy to the financial product, with possible consequences on the marketability of the bond, its circulation and its premium. For example, if the issuer decides on certification, that specific procedure is only offered by CBI, the leading private actor in the sector.  Within that procedure, even though CBI is formally the institution issuing a certification, the verification process has to be carried out by one of the approved verifiers of CBI. Next, rating and scoring a bond can be done by the usual rating agencies such as S&P and Moody’s. For verification and SPO’s, it can be carried out by a varied list of providers, however, most of the green bonds issued so far follow the standards set by either CBI or ICMA and both of the organizations have a list of either approved or recommended verifiers according to their proposed green bond framework.

At the moment, there are only 32 reviewers mentioned by ICMA and 59 approved reviewers by CBI, with 14 of them appearing in both lists. This means that there are only 77 external reviewing companies approved by one of the two largest standard setting organizations in the market. In a world where green bond issuances are reaching 1 trillion USDs yearly, the presence of so few external reviewers, and the gatekeeping role of the standard setters, inevitably raises some questions. Moreover, almost all of the approved external reviewers have headquarters, a partnership, or an office connection to a country located in the Global North. Even more, to become an approved verifier by the CBI, a company must demonstrate competence and experience in debt instruments, assurance services, knowledge of the climate bond standard, geographic coverage and technical competence, which makes the niche market more specialized so that it can then only be managed by a handful of people.

In addition, even though the adoption of a green standard in the green bond market is promoted as a necessary tool to deal with greenwashing, there are still no ‘fixed’ or universal green categories that are implemented by the external reviewers. This means that evaluation and assessment may differ and lead to different outcomes. For example, Dorfleitner et al., 2022 compared the green verification processes of the four major external reviewers’, namely CICERO, Video, ISS-Oekom, and Sustainalytics, and concluded that their green evaluations varied in scale and some of their ratings were hard to compare. The fact that ‘green’ categories are not consistent between four external reviewers triggers credibility concerns for green reviewing and raises questions about the relationship between standards and the reality of the market.

Furthermore, although some green bonds are considered success stories, there is a growing field of unsuccessful stories as well, e.g. situations where the environmental and climate impact appeared questionable (to say the least) and where the ‘greenness’ of the project was abandoned after public critiques. There are, for example, certified green projects such as Mexico City’s airport that were voted against by the citizens, or Sweden’s failed housing project originally designed for low-income citizens who weren’t able to afford the extra costs of the housing facility that came with the sustainable label . Examples like these trigger  conversations about the likeliness of exacerbating existing socio-environmental inequalities by the use of financial instruments that lack a redistributive component. In addition, some of the projects financed with green bonds were already going to be carried out regardless, so green debt becomes just an opportunity of marketing and a way of reaching out to over-accumulated capital that is waiting to be spent on ‘sustainable’ or ‘green’ activities.

The sustainable finance market where green bonds participate is expected to continue to grow. Eventually, it could even outgrow the traditional vanilla bonds market. Therefore, it requires us to thoroughly question the different phases and actors that make debt green:  mechanisms, external reviewers, standards, legal structures, and other topics related to ‘green finance’ must not be understated nor downplayed. If the international sphere and key players in the market will continue to push financial instruments to tackle climate change and other pressing social issues it is essential to critically look at that the ways in which these instruments take form and develop.

Stephanie Garcidueñas Nieto is a Ph.D. candidate at the University of Antwerp – Institute of Development Policy (IOB). Her research focuses on Green Municipal Bonds, specifically looking at the role factors and actors play at the pre-issuance phase of the bonds. Her research interests lie on climate finance, inequality, political economy of urban settlements, urban planning / smart cities and the economics of cities.

Image: byNick Youngson CC BY-SA 3.0 Pix4free

Note: This blog was originally published in the Debating Development Research Blog in June 2023.