The green bond market faces legal hurdles including “greenwashing” and a lack of international regulatory standards, according to a paper by two Australian legal scholars, raising major questions about a class of debt instruments experiencing explosive growth.

Issuances of green bonds, which companies use to raise money for environmentally friendly projects rather than general purposes, have surged from just $1.5 billion in 2007 to $258 billion in 2019, a trend the researchers expect to persist despite the ongoing coronavirus pandemic. 

“The growth in green bonds has continued through 2020 notwithstanding the COVID-19 crisis,” said Lloyd Freeburn, a corporate law fellow at the University of Melbourne, who wrote the paper, published in Capital Markets Law Journal in October, alongside Ian Ramsay, a commercial law professor at the University of Melbourne. 

The growing market has been the subject of glowing press coverage, despite a slate of issues highlighted by Freeburn and Ramsay — including whether green bonds contribute at all to reducing companies’ overall emissions. 

The scholars said the most common problem with green bonds is called “greenwashing,” in which market players mislabel standard bonds as green in order to increase their appeal to investors. This problem is exacerbated because there is no international certification process for green bonds, leading some companies to treat the phrase as a marketing tool rather than an ethical obligation to help the environment. And while organizations such as the International Capital Market Association and the Climate Bonds Initiative have both issued widely used green bond principles, they are not obligatory or universal.

Freeburn and Ramsay pointed out that Chinese companies have raised money for so-called clean coal using green bonds, for example, even though coal projects would not be considered green by standards used in other nations. 

There’s also the issue of companies that have questionable overall environmental records raising money through green bonds, the scholars noted. Freeburn pointed to green bond offerings this fall by Volkswagen and Mercedes-Benz parent Daimler, both of which were intended to boost the companies’ electric vehicle offerings. 

In recent years, Volkswagen and Daimler have both been embroiled in scandals over emissions from their diesel vehicles. Should they really be allowed to tap the same bond market as companies that solely focus on building windmills or solar panels? So far, investors have said yes — Daimler’s green bond was more than four times oversubscribed. 

“The approach through the standards is to focus on the project rather than the company," Freeburn said. “That has led to some controversies, and vehicle manufacturers are an example of that.” 

And given the trajectory of the transportation market and the red-hot valuations of electric vehicle companies like Tesla, it seems likely that Volkswagen and Daimler would have invested in electric vehicles regardless of their ability to raise money through green bonds.

“Have green bonds enabled anything that wouldn’t have happened without them?” Freeburn and Ramsay asked. “Identifying assets that owe their existence to green bonds has been described as ‘challenging.’” 

Similarly, the researchers also examined the example of Woolworths, a popular Australian supermarket chain. Woolworths issued a green bond certified by the Climate Bonds Initiative in 2019, raising money for initiatives such as installing solar panels on the roofs of its stores and distribution centers, as well as making refrigeration systems and lighting more energy efficient.  

Yet Freeburn and Ramsay noted that the industry is already moving toward energy efficiency irrespective of green bonds. “In relation to the Woolworths green bond ... it is observed that low-energy supermarkets lower costs for operators and that supermarkets in many regions are already reducing their energy intensity,” the researchers said. 

In fact, Freeburn said it is still unclear whether companies that issue green bonds become more sustainable overall. Raising money to buy solar panels can free up other money for fossil fuels, for example. “The whole issue of effectiveness could benefit with some further research,” he said.

Freeburn added that he expects investors will continue to reevaluate positions in “climate unfriendly” industries such as oil and gas, and that the effects of that shift could benefit from additional research. 

“You’ve got the danger now of climate-unfriendly industries and assets really being hit in terms of their value, and companies need to assess their operations and their whole corporate strategies to ensure that they’re not going to be compromised down the track because of climate change, and that’s a fundamental corporate governance issue,” he said.   

Both researchers were adamant that green bonds themselves will not solve climate change, and that their overall role in the current bond market is relatively small. Green bond issuances comprised more than 2% of global bond issuances in recent years, peaking at 4.4% in the last quarter of 2018, they said. 

“It’s not going to be the answer to climate change, but it’s an important component of a suite of measures,” Freeburn said.

The paper, titled “Green bonds: legal and policy issues,” was published in the October 2020 issue of Capital Markets Law Journal. Its authors are Lloyd Freeburn and Ian Ramsay, both of the University of Melbourne. Freeburn is lead author.