Written by: William Sokol
When news broke this summer about issues around working practices in British fast fashion retailer Boohoo Group plc’s factories, it highlighted one of the challenges faced by ESG investors: conflicting ESG ratings from third-party rating agencies. Green bonds may provide investors with a way of avoiding this. For investors seeking to fund projects or activities that have a positive impact on the environment, green bonds can offer advantages.
Company ESG Data: Absent or Unreliable
When it comes to ESG investing, whether in equities or fixed income, the issue of data remains a knotty one. While, for the time being, there are still problems around the absence of relevant data, their reliability (standardization and third-party auditing remain challenges) or both, there are also concerns around how said data should be interpreted. The existence of, sometimes widely, differing ratings for the same company from different rating agencies provides evidence of this.
A Matter of Interpretation
As recent research from the MIT Sloan School of Management1 regarding the divergence of ESG ratings showed, to put it simply, the interpretation of the data is what matters—in particular, the different sets of attributes (for example, greenhouse gas emissions and climate risk management) the ratings agencies use to form ratings and the differences in relative importance ascribed to those attributes. In the case of Boohoo, the divergence was apparent, with one agency having recently given it an AA rating, while pointing out “how it scored far above the industry average on supply-chain labour standards.”2
Green Bond Data: Present and Reliable
Issued by supranational organizations, banks, corporations and governments, green bonds are, essentially, like any other bond, except that they only finance environmentally friendly projects, e.g., renewable energy, energy efficiency, mass transit and others. However, and of particular importance in any discussion around ESG investing, is the fact that green bonds are defined as “green” by the projects they finance, not the broader activities of the issuer. The absence (or not) of ESG data relating to these activities does not enter into the equation; rather, the focus is solely on the projects being financed.
Data reliability, too, can become much less of an issue. (Controversies may still persist as to whether certain types of companies can issue green bonds—for example, the fossil fuel refiner Repsol S.A.3 But that is, we believe, a different question.) Projects like solar and wind are generally pretty unambiguously green and environmentally friendly, but it can be less clear when we talk about things like certain hydroelectric projects or clean coal. Rather than relying on “self-labeling”, investors can rely upon a number of independent organizations that review green bonds to establish whether the projects financed are aligned with their green bond project taxonomies—akin to benefiting from a third-party “audit” of “greenness”—and are, consequently, green.
The Green Bond Advantage
For investors seeking to fund projects or activities that have a positive impact on the environment, green bonds can offer a number of advantages. Since bonds’ green “credentials” are determined by the uses to which the projects’ funds are put, not the broader activities of the issuers, the absence (or reliability of) data around these activities is less of a concern. Without the required data on the projects, a bond cannot, de facto, be defined as green. Although the amount of data provided and level of granularity varies among issuers of green bonds, all issuers must disclose the types of projects financed and the vast majority do provide some level of post-issuance reporting.
The use of an independent third party organization may help confirm that projects align with defined taxonomies, such as the objective of the Paris Agreement, which is to limit global warming to well within two degrees Celsius above pre-industrial levels through a rapid and dramatic reduction of greenhouse gas emissions. This may provide investors with greater comfort than ESG ratings, which use data about an issuer’s broader activities and are based on different interpretations of that data, which, themselves, may not be either complete or reliable.
For example, to be included in the S&P Green Bond U.S. Dollar Select Index, bonds must be designated as “green” by the Climate Bonds Initiative, a leading organization globally that is working to mobilize the debt markets for climate solutions. This means that the bonds align with their taxonomy, which has been developed with climate scientists and is reviewed regularly to ensure it incorporates the latest research and technologies. The taxonomy is designed to align with the overall objectives of the Paris Agreement, as described above, and to do so without incurring additional harm to the environment. The focus of the analysis is on the projects financed rather than the broader activities of the issuer, making this assessment more objective and straightforward.
The VanEck Vectors® Green Bond ETF (GRNB) seeks to replicate, as closely as possible, before fees and expenses, the price and yield performance of the S&P Green Bond U.S. Dollar Select Index. The index is comprised of U.S. dollar-denominated green bonds that are issued to finance environmentally friendly projects, and includes bonds issued by supranational, government and corporate issuers globally.
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1 Berg, Florian, Kölbel, Julian F. and Rigobon, Roberto: Aggregate Confusion: The Divergence of ESG Ratings, MIT Sloan School of Management, May 17, 2020.
2 Financial Times: Why did so many ESG funds back Boohoo?, July 26, 2020.
3 Financial Times: Green bond boom brings growing pains, September 24, 2017.