Breaking down 3 myths about green bonds

“When we raise financing,” says Mika Rydman, Vice President and Group Treasurer at Neste, “we are strongly aligned with the company's overall sustainability commitment.”

According to Rydman, issuing green bonds, which is one of the most common ways for a company to finance sustainable projects, is “a very effective and a very direct way to communicate that commitment to investors.”

Getting that message across is crucial for companies like Neste, a Finnish-based company transformed from a regional oil refiner to a global leader in renewable and circular solutions, who try to meet the growing investor demand for sustainable investment opportunities.

In this pursuit, sustainable financial instruments, such as green bonds, have become commonplace.

The global sustainable bond issuance, bundling together bonds issued to finance environmental, social and corporate governance (ESG) projects, is on track to hit $1 trillion in 2021 – up 30% from 2020, says the Institute of International Finance (IIF).

Despite the rapidly growing number, the green bond market is still in its infancy – the first corporate green bond was issued in 2013 – and old myths continue to cast doubt on both the financial and environmental relevance of green bonds.

We take a look at some common myths around green bonds.

There are three potential rationales for issuing corporate green bonds, one of which is “greenwashing” defined as “the practice of making unsubstantiated or misleading claims about the company’s environmental commitment,” writes Caroline Flammer of the Questrom School of Business at Boston University in her study on green bonds from 2020.

Greenwashing is also a common myth associated with green bonds and green finance as a whole.

Flammer’s study shows that in practice green bonds are – rather than a form of greenwashing – a credible signal of companies’ commitment towards the environment.

The issue of defining what is meant by sustainable or green remains, however. One way to mitigate the exploitation of the terms is through standardization and regulation. The European Commission, for example, has proposed a European Green Bond Standard to address the issue.

Companies issuing green bonds have taken action, too. Neste, which issued its first green bond in March 2021 to finance its renewable and circular solutions, has published a Green Finance Framework to monitor the use of the proceeds from green bonds.

“The idea behind this is that investors can safely and with confidence invest in bonds that are called sustainable,” says Neste’s Rydman.

Studies show that issuing green bonds often yields profits for both the company and its stockholders.

Several studies, like this one here published by Cairn.info and another one here published in SAGE Journals, indicate that green bond issuance has a positive impact on the stock price – at least compared to the issuance of a conventional bond.

Flammer, whose study also supports the hypothesis that green bond issuance boosts stock price, writes that the cumulative abnormal returns, used to describe the difference between the expected return and the actual return, are larger for “i) green bonds that are certified by independent third parties, and ii) first-time issuers of green bonds.”

There has been a pricing benefit for green bonds, too. “Pricing incentives are not the driver here for us,” Neste’s Rydman says. Instead, it’s shifting perceptions.

“My guess is that at some point in time, green financing will become the new normal. Things will turn around so primarily companies aim to issue in green format, and if they can’t do that, there will be an increase in pricing associated with that.”

Carbon pricing is one way to financially incentivize climate action. “The more expensive emissions allowances become, the more inclined companies and borrowers are to accelerate their investments into cleaner energy solutions,” Rydman explains.

Issuing green bonds may also expand the marketplace of investors. “There are likely to be new pockets of investors emerging, or new green investors, and this may widen the investor base and access to financing for borrowers,” Rydman points out.

Sometimes the hype around sustainable finance boils over, and expectations go too high. Money doesn’t solve everything, at least not overnight.

Ioannis Ioannou, a professor of sustainable investment at London Business School and a visiting professor at Miami Herbert University, calls for patience.

“Someone would have to be naive to think that, because the markets are now thinking about sustainable investing, suddenly, the next morning, the world's going to be a better place,” Ioannou says.

Heavy industry that relies on fossil fuels has, for instance, not yet taken sufficient steps towards a green future. “Those are the really big polluters,” says Ioannou. “You can throw money at the problem, but it will take years until these technologies come about.”

However, just because something is difficult and will take time doesn’t mean it shouldn’t be done at all.

“We need to be aware that this is not only a matter of money. The question is how we spark down the line innovation in the industries that are polluting heavily.”

Investors’ power will play a big role in making that shift happen.

“Investors are likely to become more selective in terms of their investment policies over time and start to penalize or even cut out certain industries from their lending portfolios altogether,” Rydman says.

That forces action not just from the companies themselves, but also from the executives that run the companies and who in some companies, like Neste, are rewarded for making decisions that support their sustainability targets, believes Rydman.

“Is that action going to be meaningful? I think it will be. But there’ll be a path we’ll be travelling on for the next years to come,” Rydman says.

Ioannou agrees that in the future sustainability and financing will be even more tangled together. “There's no doubt in my mind that new ways of investing that fully integrate the financial and non-financial is the way to go,” says professor Ioannou.