The field that’s become known as green finance could be at a tipping point. After a decade of explosive growth, it’s running into a perhaps surprising roadblock: a shortage of projects that are green enough. That’s set off a scramble to create a wider range of debt-market instruments and incentives. Central bank officials and a growing list of investors are pushing to make the $100 trillion bond market -- one of the world’s largest pools of money -- a driving force in the increasingly urgent efforts to limit climate change.

1. What’s green finance like now?

The simplest and most established form is green bonds, which support environmentally friendly projects. The amount of green bonds sold in the first half of 2019 was up 44% from the same period in 2018; new borrowers included the government of Chile and Verizon Communications Inc. But the $500 billion or so issued so far represents just a tiny slice of the overall bond market.

2. Why is there a shortage of projects?

Green bonds are quite restrictive: Their proceeds have to be used exclusively for green purposes. That’s left many companies uncertain whether they would qualify. It’s easy for a solar energy company to certify that the money it borrows won’t be used to drill for oil. It’s harder for an oil company to do that without provoking some skepticism.

3. What else can be done?

A lot of work is going into so-called transition bonds. Only a few have been sold, but the idea is to create a separate asset class for bonds that help a “brown” company switch to a cleaner way of doing business. One of the first of these deals was for Italian gas company SNAM SpA, which raised 500 million euros ($550 million) early in 2019 for projects meant to reduce its methane emissionsby 25% by 2025. Another Italian firm, Enel SpA, this week offered investors bonds that would increase in cost if it missed a renewable-energy target.

4. Has that kind of thing been done before?

Yes, in the loan market, with sustainability-linked loans (SLLs), also known as positive-incentive loans. The fastest-growing sector in green finance, they’re tied to a specific set of actions: About three-quarters of the SLLs made to date set environmental targets, according to BloombergNEF. The interest rate can slide up or down depending on performance, but the difference is usually only a few basis points, or hundredths of a percentage point; the bigger impact may be in pushing companies to make improving their performance on environmental, social and governance (ESG) issues an integral part of their strategy.

5. What’s in this for investors?

So far, evidence suggests that there’s little difference in the performance of green and traditional bonds. There is, however, an increasing body of research suggesting that investment strategies that focus on ESG goals do better, probably because they screen out poorly run firms. So far, the rise of green loans hasn’t led to higher funding costs for companies in the extractive industries, but the idea that investor sentiment or government policies might drive up their funding costs has become an active if longer-term worry.

6. Who decides what’s really green?

So-called greenwashing is still a risk, and critics complain about a lack of global standards and inconsistency among ESG scoring methods. The European Union’s June 2019 proposals for a green-bond standard and verification system is seen as potentially creating a benchmark that could ease the sale of green securities worldwide. (Bloomberg LP, the parent company of Bloomberg News, provides ESG data, analytics and indexes via the Bloomberg Terminal and data license services.)

7. Where is green lending happening?

China’s green bond market has rushed ahead as part of the government’s effort to limit air pollution. Scandinavian investors and French lenders such as BNP Paribas and Credit Agricole have been prominent among the pioneers in this sector; U.S. investment banks now sense they need to compete. Countries with emerging economies such as Indonesia and Nigeria that are short of capital argue that green lending could help them build out their infrastructure in a climate-friendly way, giving a bigger bang per green buck. But they’re also where projects are most likely to fall short on transparency and other governance risk measures.

8. Who else is pushing for more green finance?

As the new European Commission president, Ursula von der Leyen, took office, she gave support to a French proposal for a bank that could unlock 1 trillion euros in lending related to climate change. Talk in Germany about a possible fiscal stimulus to offset a weakening economy focused on a plan to borrow to speed its shift away from fossil fuels. Most of the world’s major central banks joined in April 2019 in issuing a road map for the expansion of green lending, although the U.S. Federal Reserve was not involved.

To contact the reporter on this story: Tom Freke in London at tfreke@bloomberg.net

To contact the editors responsible for this story: James Crombie at jcrombie8@bloomberg.net, John O’Neil, Melissa Pozsgay

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