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E-MailPauline Lam is a Visiting Scholar at New York University Stern School of Business, and Jeffrey Wurgler is the Nomura Professor of Finance at New York University Stern School of Business. This post is based on their recent paper.
“Green” bonds are so labeled by the issuer because the proceeds are directed to an environmentally friendly project. Green bonds are often considered a leading capital market response to environmental challenges; over $3 trillion have been issued worldwide since the birth of the label less than twenty years ago. Prolific issuers include U.S. and international municipalities and corporations, sovereigns, and supranational entities.
Despite the market interest in the concept of green bonds, there has been little or no systematic analysis of the fundamental “real” proposition: that in buying an issuer’s green bond, as opposed to its ordinary bond, an investor is indeed contributing to some novel good, funding an activity with a sufficiently distinct environmental aspect as to merit buying the bond with the distinct label. In fact, rhetoric regarding in green bond market often takes this proposition for granted. For example, consider Apple, Inc.’s discussion of their green bond program:
Apple is committed to leaving the planet better than we found it, and our Green Bonds are a key tool to drive our environmental efforts forward. (Apple, Inc.)
Or, Michael Bloomberg, when serving as U N. Special Envoy on Climate Ambition and Solutions:
Financial markets can help solve the climate challenge by meeting the growing demand for low-carbon projects around the world…. New financial tools like green bonds are helping drive more capital to these projects …
Given that these perspectives now influence the allocation of trillions of dollars to green bonds, it is important to examine the projects that green bonds actually fund. Are they really “driving” capital to projects toward “solving the climate challenge”? Alternatively, is the label more of a marketing approach used by those with incentives to grow the market?
We analyzed how a broad set of U.S. corporate and municipal issuers used the proceeds of their first green bonds relative to how they usually invest based on other sources of finance. An issuer’s first green-labeled issue is more likely than subsequent green issues to attract special scrutiny by investors, and therefore most likely to be associated with a credibly unique project. After an extensive, bond-by-bond search for similarities and differences between the green bond’s essential green purpose, or central green aspect, and those of the issuer’s other projects—an operational measure of the “additionality” of the bond, to use the jargon of the green finance market—we examine the extent to which the degrees of additionality of different green bonds influence ownership patterns and bond prices. In short, we ask whether green bonds are different not just in their label but in their degree of novelty of the use of proceeds, and we subsequently ask how much investors notice or care.
Where do green bond proceeds actually go? The main finding is that relatively few U.S. green bonds are used to support projects whose essential green aspect is novel for the issuer. Indeed, in our sample, about 30% of aggregate corporate green bond proceeds and 45% of aggregate municipal green bond proceeds simply refinance existing ordinary debt! A small fraction of green bond proceeds, 3% of corporates and 2% of municipals, are used to acquire green assets already in use by another owner, an activity which does not have an economy-wide component of additionality. Most remaining green bond proceeds are devoted either to expanding a project that was already in progress or are used to initiate a new project that is similar in its essential green aspects to ongoing or prior projects. Such “expansion” projects constitute 32% of aggregate corporate green bond proceeds and 26% of aggregate municipal green bond proceeds in our sample, and new projects of a traditional green type consume 33% of our aggregate corporate green bond proceeds and 25% of aggregate municipal green bond proceeds. Only a handful of green bonds in our sample, amounting to 2% of proceeds for both corporate and municipal issuers, fund a project whose green aspect appears genuinely novel for the issuer. The findings do not support the view that green bonds are funneling capital to uses with environmental merits that are outside the issuer’s norm.
We also investigate the extent to which investors differentiate between the more- and less-additional green bonds they might choose. In fact, we are unable to find any evidence that investors discriminate among green bonds in this manner: (1) there is no premium, even a small one, in the offering yields on more-additional municipal bonds; (2) there is not a larger stock market announcement effect when a public corporation issues a more-additional green bond; (3) green bond index providers are not likelier to include more-additional green bonds; (4) green bond ETFs and mutual funds do not tilt toward more-additional bonds.
The results cast doubt on rhetoric that green bond proceeds are devoted to substantive, novel contributions relative to what issuers had already been doing. In practice, the label may simply distract from the fact that the funds are being allocated to business as usual—only a close look into the use of proceeds, along the lines of our analysis, can identify a green bond that funds a project that may satisfy an investor’s notion of additionality. A cynical interpretation of the results is that the green bond market is largely a financing sideshow. A more positive interpretation is that ESG-oriented investors may often be able to provide essentially similar support to an issuer’s environmental efforts via ordinary sources of finance as opposed to constraining investments to green bonds alone. Either way, the green bond label itself provides little assurance that the funds are being directed toward a project whose green traits are novel for the issuer.
