Current issues with the benchmarking of green bonds

Given that there is only minimal regulatory or judicial guidance specific to green bonds in most financial markets around the world, the reporting standards of the sustainability impact of different green bonds can vary substantially.

For green bonds to appeal to a broader audience and investors’ base however, one of the prominent issues to tackle is the lack of a rigid and consistent mechanism to benchmark the sustainability goals and green projects underlying the relevant green bonds issuance.

While the obvious answer here is implementing a green bonds regulation regime by way of updating our securities laws and regulations, an arguably even more effective solution here is the use of distributed ledger technology (“DLT”) and blockchain in the benchmarking process of the sustainability impact of green bonds.

Market practice in the green bonds space

There is currently no strong legal protection for bondholders against the issuers’ non-compliance with the proposed use of proceeds and the proposed sustainability goals underlying green bonds.

In a typical issuance, the issuer publishes a green bond framework which addresses the four pillars of the Green Bond Principles (as published by the International Capital Market Association): use of proceeds, project evaluation and selection, management of proceeds, and reporting. The issuer then publishes an annual report on the status of the proposed sustainability-related projects with an independent external review report confirming the validity of the proposed sustainability framework and adherence by the issuer to the same.

In practice however, the “use of proceeds” section in most issuance documents is very briefly drafted without sufficient details. Compared to the typical “use of proceeds” section in a prospectus for an initial public offering of equities, the brevity of the disclosures made in the issuance documents of green bonds means investors are unable to assess the sustainability impact at the time of the green bonds’ issuance.

Further, the reporting covenants in most issuance documents only point to the fact that the allocation of the net proceeds and the effectiveness of the sustainability projects are monitored by the independent external reviewer, without setting out any rubric or benchmarking criteria in such an external review exercise.

How issuers can improve green bond
frameworks and issuance documents

Given the foregoing issues, issuers should at the very least consider putting in place the following revisions to their existing green bond frameworks and future issuance documents. Alternatively, regulators should also consider putting in place rules and regulations along the lines of the following proposals:

1.        Events of default covenant: If an issuer does not adhere to the proposed use of proceeds in the relevant bond documents, yet has not defaulted on the financial terms of the bond, a bondholder might not be able to sue the issuer for such failure since the economic loss in this situation might not be apparent. 

Having specifically drafted events of default clauses allows the bondholders to accelerate the repayment of principal sum, which although is to the disadvantage of the issuer, may make the green bonds in question more attractive to investors who places considerable weight on the sustainability impact of the issuance.

2.        Reporting covenant: Issuers may consider imposing obligations on themselves to provide periodic reports on the use of the bond proceeds. Currently, a great deal of independent external review reports annexed to annual green bonds reports are merely confirmatory. 

As assurance standards are slowly becoming more and more developed for green bonds issuance, reporting covenants should also reflect a higher standard for audited green reporting, beyond mere confirmations of compliance and accuracy of representations.

3.        Use of proceeds disclosure: As mentioned above, the level of disclosure in relation to the use of proceeds in green bond issuance documents is simply not in line with that of the typical prospectus section for an initial public offering of equities.

To enhance the attractiveness of green bonds, it is incumbent for issuers to provide more details as to the sustainability impact of the proposed projects underlying the issuance. In this connection, reference can be made to the level of detail of the green projects outlined in the consultation paper on the Green Bond Endorsed Project Catalogue (2020 Edition) published by the People’s Bank of China in July 2020.

Democratizing the reporting process for
green bonds with DLT and blockchain

Despite the above proposals as to the design of green bond frameworks and the drafting of issuance documents, issuers and participants in the green bonds space should not sit back and wait for the arrival of more advanced securities laws and regulations. Instead, the time to put in place architectures that make green bonds truly “green” is now, and DLT and blockchain are here to help.

Previously, the Sustainable Digital Finance Alliance and the HSBC Centre of Sustainable Finance co-published a whitepaper on the use of DLT and blockchain to enhance the sustainability impact of green bonds. Some of the suggestions made include:

1.        Certification by stakeholders: Green projects inevitably involve the installation of green assets such as solar panels and rainwater collection plants. Issuers may consider embedding internet-of-things chips in these green assets for the purpose of gathering raw data (that will be recorded on the designated ledgers for the purpose of storing these data in a distributed manner) and thus allowing project managers, third-party certification agents (such as auditors), and the bondholders themselves to have direct and real-time access to the environmental impact of the green projects.

2.        Data evaluation and recording through DLT and blockchain: Once the raw data are in place, they can be processed through algorithms and smart contracts. The evaluation results will be transmitted and recorded on the blockchain designated for the relevant category of data to ensure the evaluation and benchmarking process is not only transparent, but also tamper-resistant as the raw data are recorded on the ledgers on a real-time basis.

In turn, the issuers (being the owners of the green assets) will have access to valuable data that can be leveraged to quantify the sustainability impact of their green bonds issuance. This allows them to improve their own credibility in the green bonds space, which makes their future green bonds issuances even more attractive to investors.

On the end of third-party certification agents and financial intermediaries, the use of DLT and blockchain in the reporting and benchmarking process of green bonds gives them access to real-time, authentic raw data without high auditing expenses.

For the green bonds space as a whole, this mechanism democratizes access to sustainable finance as it allows retail investors to not just invest in green bonds, but also monitor the sustainability impact of their underlying projects too. The end result here is an ecosystem that promotes observance of the sustainability goals and the following-through of the proposed sustainability projects.

Democratizing green bonds means
a greener future for the all of us

With self-regulation through voluntary standards enforced by the use of DLT and blockchain, the green bonds space will be able to enhance its efficiency and sustainability impact in the foreseeable future. The benefits of implementing this architecture to the stakeholders in any given green bonds issuance is multi-fold as discussed above.

Ultimately, it is hoped that with enhanced accountability and streamlined reporting and benchmarking processes in the green bonds space, the impact of democratized green bonds issuance will not only benefit these stakeholders, but the broader segments of the society as a whole.