Green bonds: how could they affect Nexus governance?

Luis Zamarioli

The implementation of the Paris Climate Agreement and the Sustainable Development Goals follow an underlying narrative that public investments are insufficient to fund countries’ financial needs. As a solution, innovative financial mechanisms and structures have been created in order to attract private capital and bridge this gap. The expression “shifting the trillions” is now a common phrase alluding to the perceived size and importance that the private sector represents in terms of public value creation. In this context, green bonds have emerged as one such increasingly important policy innovation, being used by governments to boost environment-related public budgets. It has also been promoted as a policy nudge to the financial sector away from unsustainable  activities. Below, we aim to present green bonds and raise a few questions relating to the roles played by governments in this new market and in the greening of the financial sector.

What are green bonds?

Green bonds function similarly to normal bonds. A title is issued and bought, providing ready money for the issuer while giving the buyer the chance to trade it freely in secondary markets. The “green” component differentiates them from normal bonds, as the issuer pledges to use the money only in recognised  green activities. In return, the issuer pays a price to the title’s owner for a number of years until the bond matures and must be repaid in full. By adding green instruments to debt markets, it’s expected that environment-related projects can tap into the “big money” of large-volume funds, such as institutional investors. From a policy perspective, governments can participate in the green bond market in two ways - as an issuer or regulator - each raising  questions regarding the government’s role, and responsibility in terms of limitations and possible interventions.

Governments as issuers of green bonds

First, as issuers of green bonds, local and national governments have sought to increase the present available funding for green activities by selling their debt. The European public sector has been at the forefront of green bond issuances, The European Investment Bank issued its first Climate Awareness Bonds in 2007, followed by cities such as Paris and Stockholm, the region of Île-de-France, and the Polish and French national governments. Understanding the relationship between issuance, the use of proceeds and the public interest matter enormously to safeguard the interest of present and future generations in Europe.

An immediate question regarding public issuance of green bonds is (i) to what degree tax-based revenues might be disadvantaged politically in favour of innovative financial instruments such as green bonds, since debt instruments must be repaid and incur an increase in public debt – unlike tax-based revenues. What’s more, while promoting the narrative of budget additionality for green sectors, it remains to be seen (ii) whether state capitalisation through financial markets indeed delivers capital additionality for “green” priorities. For example, does the capital raised from issuing green bonds actually represent an increase in the overall budget for green policies in the following years? If the budget for sustainable activities remains flat or increases less than that earned from bond proceeds, we can infer that the tax-based budget previously used for sustainability is now freed-up for other budgetary uses. This hardly indicates an interest in green additionality. How can we ensure that freed-up money is not used to subsidise polluting activities or to incentivise unsustainable growth? If that is the case, in light of the need for public accountability, a call should be made to reform the political narratives that seek to justify the issuance of green bonds. Also, (iii) while offering the possibility to channel larger amounts of capital into areas needed for achieving internationally agreed climate targets and sustainable goals, financial markets have the potential to shape sustainability governance based on financial criteria. Project bankability, sector capacity to generate profits, conditions of debt markets and the credit ratings of issuing governments add an additional and strengthened component to the decision for any given policy. This so-called financialisation can create a bias towards certain sectors to the detriment of others, affecting the governance of the Nexus.

Government as regulator

Secondly, the public sector can act as a regulator, as above all else it has (iv) the power to legitimise the characteristic of “green” attributed to financial titles, as opposed to definitions derived from self-regulation within the financial market. This creates procedural smoothness to issuances, which can be translated into lower transaction costs and reduced reputational risks from greenwashing claims against issuers. Going forward, another challenge lies in (v) defining green, which is not a straightforward task. A wide array of environmental complexities must be simplified into static or semi-static numerical indicators, so they can be operationalised by financial players in the form of benchmarks and used to compare and value different titles. How then, as it is the specific case of the Nexus, (vi) can we represent the constantly adapting relationships and context-dependent flows and funds across different sectors?  After all, it’s not a static picture of the environment that provides us with the best assessment of how much stress we’re putting on planetary boundaries, but often the sum of those stresses and the interdependency between different environmental functions. Under the regulatory perspective, the European Commission has been moving swiftly to discuss and develop a taxonomy of which investments might be considered “sustainable” and what might the definition of a “green” bond entail. Innovating in such unchartered waters is no easy task, but a necessary one if we’re to expect financial markets to hold their share of responsibility in shifting our economy away from environmentally unfit and unsustainable levels. Under the MAGIC project we have been closely following these policy developments, aiming to create a dialogue with the Commission for clarifying the narratives and task dimensions. We will feed this process with timely assessments from a complexity perspective and Nexus considerations and exploring the broader discussion and analysing a number of case studies in selected areas.