Thursday

23rd Sep 2021

Opinion

The risks behind the 'green bond' boom

  • Will Green bonds make the economy grow while safeguarding the environment - or are they at risk of a 'bubble'? (Photo: Bioeffect)

The EU is currently making significant efforts to play a pioneering role in green financing.

The aim is to adapt the financial system to its ambitions for climate, sustainability and clean energy.

Read and decide

Join EUobserver today

Become an expert on Europe

Get instant access to all articles — and 20 years of archives. 14-day free trial.

... or subscribe as a group

Key impulses here were the Climate Agreement of Paris, the Green Finance Study Group of the G20 and the Hamburg Climate and Energy Action Plan of the G19.

Including financial markets in a climate strategy is a logical step with insufficient public funds to finance the necessary investments in green technologies.

At the same time, the financial sector is showing interest in financing green technologies.

Green Bonds are regarded as a key green financial product.

Since the first issuances by the European Development Bank and the World Bank a decade ago, the issuance volume of green bonds has grown enormously.

While a global volume of $3bn was issued in 2012, the issuance volume increased to $157bn in 2017.

The heightened demand for green bonds can be attributed either to greater awareness of sustainability and to the downsides of climate change, but also to the fact that green bonds are more transparent than traditional bonds.

Investors in a traditional bond have limited information on how proceeds are invested, while green bond issuers are allowed to use the funds raised only for green investments. They also document this for the investors.

Definitions needed

However, for such a market to thrive, investors need a definition of green investments and a definition of what a green bond is. In addition, disclosure standards are required so that investors can easily access and compare information about these bonds.

The EU's main effort to strengthen the green bond market is to legislate for a common taxonomy on green bonds and to increase the demand for green bonds through a green supporting factor in bank equity capital regulation, i.e. lower capital requirements for green bonds.

While the taxonomy is relevant to all investors, it was specifically intended to encourage banks to lend money for green investments.

However, this effort must be viewed critically.

Since a bank's equity capital is a limiting factor for lending, the design of capital requirements for banks directly impact demand for specific types of assets of banks.

Since a bank's equity is a buffer against unexpected losses, bank regulation should ensure that banks hold sufficient equity capital relative to their risk.

However, a green supporting factor means that banks will have less equity capital against the unexpected losses of a green bond.

The only rationale for lower capital requirements for green bonds is a lower probability of default compared to traditional bonds.

As long as this is not the case, the green supporting factor would only result in banks being undercapitalised against losses on green bonds.

Political project

As the green bond market is a political project, there is a risk of favouring green bonds in financial market regulation in order to achieve policy goals.

From our calculations, we derive a risk of political intervention to stimulate the demand for green bonds.

The annual green bond emissions would then have to increase by a factor of 45 to finance the potentially required annual green investments of up to $7trn.

To meet the additional investment necessary to achieve the Paris climate target, the annual green bond emissions would have to increase by a factor of 4.5.

In the past, the US made the mistake of using the Community Reinvesting Act to increase housing investment through policy instruments aimed at banks expanding lending to households.

The EU should not make the same mistake and overuse the financial system in order to achieve environmental goals.

The emergence of a green bond bubble and the bursting of that bubble would be detrimental to the financial sector and hinder the achievement of climate targets as investors refrain from investing in which they have previously lost money.

In order to promote green investments, the EU should therefore prefer to rely on existing environmental policy instruments.

Instead of pushing for a rapid growth of the green bond market, the EU should strive for its organic growth.

This should be driven by the market.

To this end, the proposed harmonisation of taxonomy within the EU is a necessary step, as different national taxonomies would hamper the emergence of cross-border green bond markets.

The EU should ensure consistency in the regulatory framework for green bonds with other rules for financial institutions and ensure consistency in the future.

Author bio

Dr Adriana Neligan and Dr Markus Demary are senior economists at the German Economic Institute, a private research institute in Cologne, which is an advocate of a liberal economic and social order.

Disclaimer

The views expressed in this opinion piece are the author's, not those of EUobserver.

Interview

Ex-MEP pushes CCS projects, despite 'wasted money'

Chris Davies admitted that the amendment he wrote to set up a fund to finance carbon capture and storage projects failed because it had design flaws and no one expected the carbon price to plummet.

Experts threaten to quit over new EU 'green finance' rules

Nine members of the expert group advising the European Commission on sustainable finance rules say criteria for gas, forestry and bioenergy are "a clear contradiction to climate science" - threatening to step down if lobbying and politics prevail over science.

EU climate diplomacy can make the difference

At this critical time, with climate change increasingly urgent and with reactionary, anti-science forces threatening processes of cooperation, the EU climate mission can reassert the common values and aspirations which Europeans share.

News in Brief

  1. French ambassador to return to US after Macron-Biden call
  2. Borrell: EU needs armed force independent of US
  3. Polish region does U-turn on gay rights
  4. Johnson makes fun of French anger on submarine deal
  5. Ukraine vows 'tough response' after gun attack on top aide
  6. Poland again delays ruling on primacy of EU law
  7. EU to table emergency proposals on gas-price surge
  8. EU delays first set of anti-greenwashing rules

Stakeholders' Highlights

  1. Nordic Council of MinistersNATO Secretary General guest at the Session of the Nordic Council
  2. Nordic Council of MinistersCan you love whoever you want in care homes?
  3. Nordic Council of MinistersNineteen demands by Nordic young people to save biodiversity
  4. Nordic Council of MinistersSustainable public procurement is an effective way to achieve global goals
  5. Nordic Council of MinistersNordic Council enters into formal relations with European Parliament
  6. Nordic Council of MinistersWomen more active in violent extremist circles than first assumed

Latest News

  1. More French names linked to Russia election-monitoring
  2. Negotiations set for new, tougher, EU ethics body
  3. Lead energy MEP silent on gas meetings before vote
  4. WHO makes major cut in 'safe' air-pollution levels
  5. EU negotiators defend high Covid vaccines prices paid to pharma
  6. The EU's 'backyard' is not in the Indo-Pacific
  7. French MEPs lead bogus EU monitoring of Russia vote
  8. Europeans think new 'Cold War' is here - but not for them

Join EUobserver

Support quality EU news

Join us