The emergence of green bonds presents an attractive sustainable vehicle for fixed income investors, though not without drawbacks. The potential value of green bonds is obvious from the name; the securities prioritize the importance of environmental concerns as a means of either reducing risk or forming a competitive advantage when using the proceeds from the sale of the note. Green bonds also send the market a positive signal about their issuers’ intentions and priorities.

Although green bonds have begun to blossom as an asset class, with impressive growth since they first appeared in 2008, the size of the asset class is still that of a tiny sprout relative to the total bond market.1 Green bonds make up just 0.13% of fixed-income assets under management worldwide. This figure will likely grow, as institutional and retail investor demand for fixed-income investments that consider environmental, social, and governance (ESG) factors remains in the early stages. And that’s where confusion may lie ahead: green bonds have idiosyncrasies in their structures, ratings, geographic makeup, and ultimately, performance. Investors only broadly familiar with ESG investing need to account for these idiosyncrasies before allocating to this budding asset class.

How green are green bonds?

Since 2008 when green bonds were born from a limited public-private experiment, they have experienced a strong rate of growth. According to the Climate Bonds Initiative, in 2017 a record $155.5 billion of green bonds were issued, up from $87.2 billion the year before, representing 78% year-on-year growth.2 Unsurprisingly, as the rate and diversity of green bond issuance has grown, the characteristics of green bonds have come under greater scrutiny within the ESG community. Essentially the question comes down to, "How green is green?"

So far, this question has been difficult to answer with authority.

One reason is that green bond issuers aspire to meet voluntary standards and principles, but ultimately green bonds are not regulated or subject to a formal compliance process on their "green" status. Currently, the Green Bond Principles and the Climate Bonds Standards are the main international frameworks employed to label green bonds, but compliance is neither screened nor ensured by any one authoritative third party.

One example of how the ambiguity of green labeling has sown confusion is embodied by one of the green bond market’s most notable participants, China.

In the last two years, China ranked as the largest green bond issuer, dominating global issuance with $25 billion in 2017 and $33 billion in 2016.3 China's issuance equated to nearly 40% of the $81 billion of green bonds issued globally in 2016.4 China is expected to become an even more dominant issuer of green bonds as the People's Bank of China,China's central bank, says the country will need an estimated $320 billion a year to meet its government’s pollution reduction targets.5