Green grow the markets, O

OCCASIONALLY a market appears out of nowhere. So it is with “green bonds”, instruments which tie the proceeds of a bond issue to environmentally friendly investments. Issuers of green bonds raise money, promising to spend it on (for example) building wind farms or less-polluting factories. In 2012 $3 billion of such bonds were sold. In the first six months of 2014, the sum was about $20 billion, nearly twice as much as in 2013 as a whole. All green bonds are investment grade; many have been two or three times oversubscribed; half were issued by companies, a switch from 2013, when most green bonds were sold by international agencies such as the World Bank.

Climate Bonds Initiative, a research group, reckons the cumulative value of all green bonds will be around $50 billion by the end of 2014. That figure is tiny compared with the total size of the bond market ($80 trillion) or the cost of reducing greenhouse gases (anyone’s guess). But compared with most streams of income for environmental purposes, it is huge. This year’s issues will be two or three times more than German taxpayers will spend subsidising wind and solar energy—the largest green subsidy in Europe.

Markets may appear from nowhere, but they don’t appear from nothing. Green bonds are a case study not only in how markets grow, but what needs to be done to keep them from imploding. Obviously, you start with willing buyers and sellers. According to one estimate, 55% of pension-fund assets are exposed to climate risks (including heavier regulation of dirty industries); buying green bonds helps offset such risks. No surprise that Sweden’s public-sector pension fund was one of the earliest investors. Now, private asset managers are piling in, too. Last November Zurich Insurance said it would buy $1 billion of green bonds, with the portfolio run by BlackRock, an asset manager. Christopher Flensborg of SEB, a Swedish bank that is the largest underwriter of green bonds, reckons more than 250 institutional investors have bought at least one green bond, up from a handful two years ago. The largest bonds—such as a $3.4 billion issue from GDF Suez, a utility—are now big enough to appear in general bond indices. On July 1st Barclays, a bank, and MSCI, an information firm, said they would launch the first green-bond index.

Green bonds also attract new investors. When Unilever, a consumer-goods company, issued a £250m ($416m) green bond in March, 40% of the issue was snapped up by people outside Britain—an uncommon response to a sterling bond. Central banks and other official bodies usually buy 75% of the African Development Bank’s (AfDB) benchmark bonds. But when the AfDB issued a green bond last October, asset managers, insurers and pension funds took over 70%.

Having more investors ought to make it easier for a company to sell bonds in future. There is also evidence green bonds can sometimes outperform less colourful ones. Last year the yield on almost all South Korean bonds rose 0.6 percentage points in response to an outbreak of sabre-rattling by North Korea. But that of a green bond issued by South Korea’s ExIm bank rose only 0.1 points. Green bondholders proved less skittish than others.

A market needs standardised products. The World Bank has helped by proposing eligibility criteria for projects financed by green bonds, deciding on a system for ring-fencing proceeds to ensure they go to the right things and sketching out what sort of reporting and compliance systems investors would need. Earlier this year 13 banks drew up a shared set of principles governing different categories of bonds; 49 institutions have signed up.

Nonetheless, there is far from universal agreement over the question, “What makes a bond green?” At the moment the answer is, “If someone says it is.” At first, that someone was the World Bank’s environmental department, which made sense when the bank issued most of the bonds. But something else was needed as corporate green bonds came along. Now independent groups have emerged to give second opinions, such as the Centre for International Climate and Environmental Research in Oslo (CICERO), a group of Norwegian academics. The market has grown so fast that CICERO has just announced a partnership with four other academic institutions, including Tsinghua University, to increase capacity (not coincidentally the first yuan-denominated green bond has just been issued). But sometimes the opinion is that of the issuer itself: Toyota this year sold a $1.75 billion bond (to finance sales of zero-emission cars) on its own say-so.

The trouble with this sort of discretion is that different people have different views. Is fracking green? Is nuclear power? The definition is likely to be tested further because a big oil firm is working on a green bond to finance a carbon-capture and storage (CCS) scheme. CCS is an important technology—but oil firms are, for the most part, seen as beyond the pale by greens.

The market does not need a single definition of greenery. But it does need to strike a balance between accepting anything (which would dilute the attraction of green bonds as instruments to diversify climate risk) and being so strict that hardly anyone can meet the criteria. It also probably needs a more systematic approach to environmental assessment, nearer to a credit-ratings system. Without it, the helter-skelter growth of the past two years could wilt like a rice paddy in a drought.

_{Correction: In an earlier version of this article we referred to Zurich Re as the company who would buy $1 billion of green bonds. This was in fact Zurich Insurance. This was corrected on July 4th 2014. Sorry.}