In 2007, a historic document landed on the desks of leaders around the globe. The Intergovernmental Panel on Climate Change, assembled by the United Nations Environment Programme and the World Meteorological Organization, had published a report providing scientific data showing that it was “very likely” that human action was directly linked to climate change. The impact of industrialization on the climate would have to be addressed, and governments would have to take action to lessen the carbon footprint of humanity.

In November 2008, the World Bank released the first green bond—a fixed income instrument created to raise capital for “green” initiatives. In theory, these bonds would be a vehicle with which investors could fund environmentally sustainable projects without compromising on returns. The bonds would trade in the same way that corporate bonds do, seamlessly integrating into the market.

Except, that’s not exactly what has happened. Companies and governments have issued bonds, but liquidity in this market remains low, as demand for these instruments outstrips supply.

It’s not that no one is issuing green bonds. Apple issued $2.2 billion of debt in 2019 to raise capital to allow the tech giant to cut carbon emissions from its providers and develop more energy-efficient products. In a report published this year, Moody’s Analytics said it expects issuance of green bonds to climb 24%, from $323 billion in 2019 to $400 billion in 2020. The Climate Bond Initiative (CBI), a non-governmental organization (NGO), released a study on the green bond market in 2019 that noted a 51% increase in green bonds in 2018, and a new global record of $257.7 billion total green bond issuance. On the London Stock Exchange Group’s (LSEG’s) newly launched Sustainable Bond Market (SBM), there are 234 financial instruments that have raised over $51.9 billion.

While the market in these instruments is growing, it’s still very small. The European Securities Markets Authority (Esma) says in its Trends, Risks and Vulnerabilities report that liquidity is tighter for public sector green bonds than for conventional bonds in the EU. Those 234 instruments on the SBM look rather insignificant when compared with the 15,000 instruments on LSEG’s whole debt market.

Paul Sinthunont, a senior analyst at Aite Group, says there is over $100 trillion in debt issuance worldwide and green bonds are estimated to be $200 billion to $400 billion of that, which is less than 1% of the total debt market.

At the same time, investors do want to put their money into green bonds. Elena Chimonides, a fixed income product specialist at LSEG, says green bonds are one of the fastest-growing products of interest for clients, market participants, and stakeholders LSEG speaks to.

It’s in this environment that tech and data providers are seeing a need to provide tools to help traders identify and trade green bonds, and increase liquidity in the green bond market. These providers include fixed income electronic trading platforms MTS and MarketAxess, both of which are creating products specifically aimed at aiding green investment initiatives.

A limited supply of bonds means that the early focus of the green bond market has been on primary issuance. Whether government or corporate issuance, a lack of supply and secondary liquidity necessitates a buy-and-hold strategy.

Frank Cerveny, MTS

Demand Outstrips Supply

Frank Cerveny, head of global relationship management at MTS, says the modest number of green bonds in comparison to conventional bonds means that the demand for them is largely outweighing supply. “A limited supply of bonds means that the early focus of the green bond market has been on primary issuance,” Cerveny says. “Whether government or corporate issuance, a lack of supply and secondary liquidity necessitates a buy-and-hold strategy.”

As a subsidiary of the LSEG, MTS works closely with the SBM, which the exchange launched in October last year.

Cerveny believes that advancing the trading technology surrounding green bonds will improve liquidity in this market, and thus drive new issuances. “If you can increase the transparency, you can increase liquidity, bring more confidence to the market, tighten bid/offer spreads, and ultimately lower the cost of financing,” he says.

Initiatives like green bonds and investing in companies that have solid practices around environmental, social and governance (ESG) factors have drawn criticism of greenwashing from the public sector, but Oliver Clark, head of product development at MTS, says green bonds are starting to prove they are more than just a marketing pitch. With governments promoting green initiatives, the investment community has followed suit, and Clark says he has seen increased green awareness and interest from his clients.

He says much of the progress in thinking around environmental concerns has been driven, at least recently, by BlackRock’s new emphasis on sustainable investing. The world’s largest asset manager “actually put a line in the sand, effectively driving policy with real money,” Clark says.

BlackRock CEO Larry Fink said earlier this year that the firm would put sustainability at the heart of its investment decisions, and lower exposure to fossil fuel companies. BlackRock did not respond to requests for comment on this article.

In 2018, MTS started flagging bonds as green on BondVision, its multi-dealer-to-client platform for government bonds and credit. Traders can identify green bonds and compare them with those that fail to qualify as green. Investors can see if there is an additional cost or premium required to own or trade the green bonds. Between 2018 and 2019, green bond trading volumes on BondVision increased 179%, and now there are 426 green bonds listed on the platform.

Cerveny and Clark say transparency is the most important aspect of green bond trading. Transparency will unlock liquidity and, consequently, issuance.

“The more prominent or the easier it is to find the green bonds on our platform, the more liquidity and more money will find it,” Clark says.

Regulation Drives Transparency

Transparency will be driven by the public sector, as standards and regulation will ensure stricter certification of green instruments as actually funding sustainable activities by corporates and governments, and bring more trust to the sustainable bond market. Some of the most comprehensive work in the public sector on sustainable finance generally has been the EC’s Action Plan on financing sustainable growth, which the European Commission laid out in 2018.

As part of the plan, the EC set up a Technical Expert Group (TEG) on sustainable finance. The TEG was responsible for developing recommendations to the EC on a classification system on sustainability, called the EU Taxonomy, and an EU Green Bond standard. The TEG’s final report on the standard was published last year, and its final report on the taxonomy was published in March 2020.

The TEG’s green bonds standards link the use-of-proceeds—how the funds raised from the issuance of the bonds are actually spent—of green bonds to the EU Taxonomy’s standards for what constitutes sustainable activity, and prescribe some standards for allocation and impact reporting. The green bond standard will be voluntary, available to issuers anywhere in the world that wish to align with best practices in the market. The standard will also put in place a registration scheme for external verifiers.

There are other initiatives outside of government, however, to ensure some transparency around green bonds. The CBI runs what it says is the only international certification scheme for these instruments, setting definitions and eligibility criteria for certification. The NGO also has a pre- and post-issuance assurance framework.

Similarly, the International Capital Markets Association (ICMA), a trade association, has voluntary guidelines for the process of green bond issuance, which it published in 2014 and updated in 2018, with the aim of recommending transparency and disclosure in issuance. Major investment banks including JP Morgan, BNP Paribas, Deutsche Bank, and Citi are signatories to the ICMA principles.

CBI founder and CEO Sean Kidney says its certification works by making the ICMA voluntary requirements mandatory: A bond has to meet all of the principles to be qualified as green by CBI. “For the certification to be valid, you must meet all of them: You can’t cherry-pick; you have to meet this independent definition, which is the CBI definition of what is green,” Kidney says.

MTS’ Clark says the green bonds on BondVision have been certified by the CBI.

Rebecca Healey, co-chair of the EMEA regional committee and EMEA regulatory subcommittee at FIX Trading Community, says the EU Taxonomy will bolster the reporting quality of green bonds.

“[The lack of data reported around ESG] is a huge challenge at the moment, because so much of the data available currently is voluntary and it is also subjective,” she says, meaning that every individual company or issuer may have a different definition of what they believe to be a green bond.

Subjectivity, coupled with inconsistent ESG reporting, means that the information available is skewed, Healey adds. “Firms can be at risk of unintentionally greenwashing. Added to which, information is difficult to get ahold of and can be sporadic in how and where it is reported. This is where greater standardization in how data is reported will be extremely helpful for organizations.”

Being able to find and locate green bonds that satisfy that investment mandate requires some work, because there are a small number of green bonds out in the marketplace.

Chris Concannon, MarketAxess

Lost at Sea

In addition to not having a universal standard for what is green, the bonds that have been qualified, either by CBI or by another means, get lost in the sea of corporate bonds, says Chris Concannon, president and COO of MarketAxess. This hinders a portfolio manager’s ability to fulfill their ESG investment mandates.

While green bonds are a small part of the fixed income market, they are growing, due in part to the investment strategy developing over major fund complexes, Concannon says.

Concannon, who was previously president and COO of CBOE Global Markets, tells WatersTechnology that traders and portfolio managers who use the MarketAxess trading technology are getting mandates from their employers that require ESG investment, cutting across equities and fixed income. “Being able to find and locate green bonds that satisfy that investment mandate requires some work, because there are a small number of green bonds out in the marketplace,” he says.

Concannon says MarketAxess recognized that clients were struggling to identify green bonds in the market, not knowing where to look for or how to find them. Clients were also looking for green alternatives that had the same characteristics as non-green bonds. The company’s response has been to launch features like the “Like Bonds” tool, which helps identify those characteristically similar green options. It also added a green bond tab and green bond identifiers to make locating bonds more efficient. Users are able to look at how the bonds are trading, and their liquidity, which Concannon hopes will help portfolio managers as well as traders.

Concannon says MarketAxess has seen huge demand for trading tools within the green bond market, and hopes to continue to respond to customer requests. The company plans to release new products later this year around this market.

As firms like MarketAxess and MTS continue to roll out new features to aid the trading of green bonds, the question of whether the effort is worth the reward still stands. Kidney says CBI predicts the growth of green bonds will keep rising.

And there is evidence that, while debt capital markets have generally placed less emphasis on ESG and sustainable investing than the equities world, fixed income investors are seeing value in specifically green instruments as issuance rises. So even as they are dwarfed by the conventional bond market, perhaps trading tech can unlock the potential of green bonds—especially as the world becomes more concerned about the impact of the real economy on the climate.