In this article, FactSet partner firm Emmi utilizes FactSet fixed income data to consider whether investors can use green bonds to reduce climate transition risk in portfolios. To allow a comparison between green and non-green bonds, all corporate bonds are assessed, amounting to more than $24 trillion of outstanding global corporate debt.
Green bonds have emerged as a growing debt instrument for some asset managers, with estimates suggesting over $2 trillion in issuance over the past five years. However, very little analysis has been done to answer a key question: Does issuing a green bond lower companies’ or investors' climate transition risk?
As defined by the International Capital Market Association, green bonds are financial debt instruments that function in the same manner financially as traditional bonds, but they differ in that the proceeds must be exclusively applied to finance or re-finance, in part or in full, new and/or existing eligible green projects.
Comprising 4% of total outstanding bonds, their defining characteristic is that all funds raised go toward environmental projects, including: renewable energy; energy efficiency; pollution prevention and control; sustainable management of natural resources and land; conservation of terrestrial and aquatic life; clean transportation; sustainable water and wastewater management; adaptation to climate change; uptake of reusable, recyclable, refurbished, or eco-efficient materials; and buildings that meet recognized standards.
In terms of the maturity profile, green bonds typically have shorter terms (maturing before 2030) than general non-green corporate bonds, which more commonly have medium- to long-term maturities.
Assessing the financial impact of different climate scenarios and associated carbon pricing on a bond requires three steps:
Calculating the issuer’s financed emissions
Apportioning the climate budget at the company/issuer level
Calculating the potential carbon liability (PCL) of the outstanding debt from carbon pricing
(View the full calculation details in Emmi’s white paper, Corporate Fixed Income Climate Transition Risk.)
Emmi’s analysis reveals substantial climate transition risks across multiple sectors by 2030 under the Network for Greening the Financial System (NGFS) 1.5°C or 2°C scenarios. For example, under the Current Policies scenario, some companies' debt still remains at extreme financial liability without any future changes in carbon pricing.
This suggests their business models may be inherently unstable in the face of carbon pricing found today, something important for bond investors to consider in capital allocations.
The following tables also suggest that climate transition risks are not just concentrated in obvious carbon-intensive sectors. Risk extends across the industrial economy, potentially affecting various supply chains and financial markets. The large number of bonds involved indicates that these risks are widely distributed among investors and financial institutions.
Overall, Emmi’s analysis suggests that green bonds do not offer lower climate transition risk for investors by 2030, since the risk lies in the issuer's overall risk, not the bond.
By 2030, over $1trillion of this outstanding corporate debt is at risk of at least 90% carbon cost liability under 1.5°C Net Zero scenarios. That equates to over 4% of the listed corporate bond market at extreme financial carbon exposure over the next five years.
Under more moderate Paris-aligned 2°C scenarios, Emmi still finds about $200 billion of debt issued across 71 companies at extreme financial liability by 2030.
For investors to reduce their transition risk they could consider investments in companies and/or sectors that are making efforts to address the root causes of climate risk. For example, by committing to reduce carbon emissions, setting measurable targets, diversifying revenue sources, and investing in new low carbon products.
To learn more about the analysis and climate transition risk, download the Corporate Fixed Income Climate Transition Risk white paper from Emmi and visit carbon diagnostics on factset.com.
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