Financial Services

Despite the best of intentions green ‘use of proceeds’ bonds are a distraction and a false hope

June 28, 2017


June 28, 2017

Ben Caldecott

Director of the Sustainable Finance Programme

Ben Caldecott is the founding Director of the Oxford Sustainable Finance Programme at the University of Oxford Smith School of Enterprise and the Environment. The Oxford Sustainable Finance Programme is a multidisciplinary research centre working to be the world’s best place for research and teaching on sustainable finance and investment. 

Ben is concurrently an Adviser to The Prince of Wales’s Accounting for Sustainability Project, an Academic Visitor at the Bank of England, and a Visiting Scholar at Stanford University. He serves on a number of boards, including the UK Green Finance Taskforce, City of London Green Finance Initiative, University of Oxford Socially Responsible Investment Review Committee, and the Green Alliance.

Debt capital markets, particularly bond markets, will play a critical role in financing large parts of the transition to global environmental sustainability.

These deep pools of low cost capital are well suited to the capital-intensive projects and technologies that need to be deployed to implement both the Paris Agreement and the Sustainable Development Goals (SDGs).

Enter ‘green’ bonds. These should help sustainable and financeable activities access lower cost capital, thereby improving their economics, and enabling more projects to happen. This would help the world become greener and cleaner.

The green bonds that now dominate the conversation in ESG and Responsible Investment circles are the kind issued by a sovereign, multilateral institution, or company as ‘use of proceeds’ bonds. For example: a government issues a green bond and says it will spend the money raised on funding environmental activities; a multilateral development bank (MDB) issues a green bond and says it will use the funds to finance its climate change projects; an oil company issues a green bond and says it will spend the money on making its business more energy efficient; a railway company issues a green bond to finance the construction of a new railway or to refinance existing debt. According to SEB approximately 88% (US$50bn) of total year-to-date green bond issuance was for green ‘use of proceeds’ bonds and there have been recent issuances from Apple ($1bn) and the French Government (€7bn).

This sounds promising. Green activities are being financed through these green ‘use of proceeds’ bonds. The sovereign, multilateral institution, or company issuing the bond feels good and gets to highlight how green it is. The investor buying the bond gets to say it is supporting green activities. The organisations involved in the market can say they’re helping to finance the transition to sustainability. What’s not to like?

Unfortunately, this is the point at which superficiality meets reality and where it gets uncomfortable for the green bond advocate. Here are some reasons to think that green ‘use of proceeds’ bonds are a real problem and not a solution:

First, there is no cost of capital benefit for the issuer and consequently no economic advantage. The bonds are priced the same as other similar bonds issued by the same issuer. The government, MDB, oil company, and railway company are not accessing lower cost capital. The cost of capital is the same as if they just borrowed normally in the debt capital markets. In fact, as they must pay for the bond to be verified there is an extra cost of issuance. That in effect increases the cost of capital, albeit by a small amount. At best there is no cost of capital benefit for the issuer and at worst it is more expensive.

Second, the activities would be financed anyway. The green ‘use of proceeds’ bond is financing activities that would have happened and been successfully financed. The government spends money on the environment that would be funded by either taxation or borrowing, the MDB finances climate mitigation projects and would issue bonds to fund these activities as it does normally, the oil company was going to improve its energy efficiency and finance this from its cash flows or borrowing, and the railway company was going to get its new railway financed and successfully refinance its debt obligations. None of these things happened because a green bond was possible. They were going to happen anyway and in the absence of green ‘use of proceeds’ bonds would have been financed at the same cost of capital.

Third, there is a substantial risk of greenwashing and this seems to be happening already. Poland, arguably the least green country in Europe and the country that persistently undermines EU action on climate change, managed to become the first sovereign issuer of a green bond. There are other examples. In the end this is a material risk for investors holding green ‘use of proceeds’ bonds. A scandal or two, where the funds are being used for non-green activities, will almost certainly happen. The mere prospect of this may introduce liquidity risk for some types of green ‘use of proceeds’ bonds. It would not surprise me if they trade with an illiquidity discount in the future. Remember, this happened in the international carbon market when the market started to discount (due to reputational and then policy risk) Certified Emission Reductions (CERs) generated from large scale hydro and industrial gas projects.

Fourth, green ‘use of proceeds’ bonds suck up time and energy – they are a dangerous distraction given the scale of the sustainability challenges we face. So much time has been dedicated to this area. You just have to look at the number conferences and events organised with sessions focused on green ‘use of proceeds’ bonds and the incessant lobbying of governments by their advocates to secure tax incentives and other benefits.

Fifth, because of the staggeringly high hype to environmental impact ratio and the risk of greenwashing, they could quite possibly undermine broader efforts to mainstream sustainable finance and investment. Green bond advocates claim that green ‘use of proceeds’ bonds will help mainstream sustainable finance and investment by getting investors used to ‘green’. I disagree. Labelling does little to help investors become familiar with underlying cash flows and activities, in fact it seems to encourage complacency. Scandals and greenwashing could undermine interest in anything ‘green’. Poor performing clean tech funds in the late noughties and the collapse of the carbon market at around the same time scarred many institutional investors. The same could happen as a result of green ‘use of proceeds’ bonds.

Green bond advocates need to be honest about what a green ‘use of proceed’ bond does and does not do. While green ‘use of proceed’ bonds don’t directly support the transition to sustainability, they might do indirectly through encouraging issuers to think about green activities and by creating market momentum towards green. These benefits are hard to define and capture, but they might be significant. Though few green bond advocates seem to spend time pinning down and understanding these possible positive contributions.

But even if such benefits existed they must also be assessed in the round together with the arguments against. On balance, even being generous with the hypothesised benefits, I think that green ‘use of proceeds’ bonds are a marketing gimmick that have very little (if any) positive impact on the real economy. They will likely suffer from liquidity issues in the future. The hype surrounding them will backfire (probably through a series of greenwashing scandals) and this will then hold back the development of sustainable finance and investment more generally. Hence this article and my warning.

Instead of green ‘use of proceeds’ bonds, we should be talking about or green asset-backed securities used to re-finance operational cash-flow producing assets. Such re-financing actually lowers the average cost of capital for green activities by creating an exit for early stage capital and by turning equity and bank loans into cheaper long-term debt. They also free up capital that can be recycled back into construction and development. There needs to be a torrent of such issuance in the coming years as the stock of low carbon infrastructure in Europe and elsewhere is refinanced to free up capacity on company and bank balance sheets. It is an imperative that this market develops quickly. Issuers, investors, and governments should put the green infrastructure bond agenda at the very top of their priority list and dump green ‘use of proceeds’ bonds before they do any more damage or distract further attention from the things we actually need to do to deliver on Paris and the SDGs.



The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Economist Intelligence Unit Limited (EIU) or any other member of The Economist Group. The Economist Group (including the EIU) cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in the article.

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