Green Bonds; Empty Promises

The market for green bonds has grown enormously, with issuance volumes well over half a trillion dollars in some years (See Figure 1, using data sourced from Refinitiv, below). The issuers of these bonds say they plan to use proceeds for projects with environmental benefits, such as biodiversity conservation and renewable energy. Indeed, massive investment is needed to support the transition to a net-zero economy and efforts to adapt to and mitigate the effects of climate change. Although excited about this new type of finance, we were skeptical. After all, bond issuers can already use proceeds to finance projects with positive environmental benefits. What does the label ‘green’ add? We decided to investigate the legal terms that prevail in the market for green bonds. The resulting paper gives away our conclusions in the title: Green Bonds; Empty Promises.

The term ‘bond’ implies a solemn promise (eg, ‘my word is my bond’). Historically, a promisor would imbue their promise with credibility by posting a bond, which would be forfeited if the promise wasn’t kept. So, the very moniker ‘green bond’ implies a heightened obligation to promote activities that are good for the environment. In legal terms, this means we would expect green bonds to include unequivocal promises to fund projects with positive environmental impact and clear mechanisms for enforcing those promises. For example, the contract might impose meaningful penalties, or allow investors to demand their money back, if the issuer fails to use proceeds as expected.

We parsed the terms of over 1,000 corporate, municipal, sovereign, and supra-national bonds issued from 2012-2022. The story that emerges is simple. Green bonds promise next to nothing. They include no enforcement mechanisms. And over time, they made these facts increasingly clear to investors.  Figure 2, taken from our paper, shows the patterns we found in our data, where the strength of the green promises seems to decrease over time.

Here are just a few examples, drawn from the subset of green bonds issued by sovereigns (which are among the most enthusiastic of green bond issuers). A 2020 bond issued by Mexico, intended to fund sustainable development goals (SDG), says:

Although the SDG Sovereign Bond Framework contemplates certain practices with respect to reporting and use of proceeds, any failure by Mexico to conform to these practices does not constitute or give rise to a breach or an event of default under the notes…. The SDG Sovereign Bond Framework and any practices contemplated thereunder are not incorporated into this prospectus supplement or the terms of the notes. They do not establish enforceable contractual obligations of Mexico.

A 2021 Chilean bond:

Although the Sustainable Bond Framework contemplates certain practices with respect to reporting and use of proceeds, any failure by Chile to conform to these practices does not constitute or give rise to a breach or an event of default under the notes or any other instrument…. The Sustainable Bond Framework and any practices contemplated thereunder are not incorporated into this prospectus supplement or the terms of the notes. They do not establish enforceable contractual obligations of Chile or any other person.

And one from Hungary in 2021:

While it is the intention of the Issuer to apply the proceeds from the placement to finance or refinance Eligible Green Expenditures, it is under no legal obligation to do so. There is also no legal obligation to ensure that such Eligible Green Expenditures will be available or capable of being implemented as anticipated and, accordingly, that the Issuer will be able to use the proceeds for such Eligible Green Expenditures as intended. In addition, there is no legal obligation to ensure that Eligible Green Expenditures will achieve the originally intended impacts (environmental, social or otherwise) or outcomes in the manner expected.

To be perfectly clear: The issuer of a green bond does not promise to finance green activities of any kind, in any amount. At best, the issuer represents that it intends to finance green activities but remains free to change its mind. Moreover, the lack of green promises is just the beginning. In the unlikely event an investor could locate an actual promise to finance green activities, there is no enforcement mechanism. Green bonds, like other bonds, are full of provisions giving investors enforcement options: the right to accelerate the debt, the right to sue, etc. But the failure to invest in green activities will not trigger these provisions. Put simply, even if the issuer made and broke a promise to finance green activities, the investor in a green bond would have no meaningful remedy. 

Looking for insight, we talked to over fifty industry insiders—the lawyers, bankers, investors, ratings specialists and government officials who operate in the green bond market. These conversations did nothing to ameliorate our skepticism. The insiders knew full well that green bonds were utterly toothless. Many on both the issuer and investor sides told us emphatically that they opposed any regulatory attempt to impose legal liability for failure to honor green promises. Why? The explanation we got was that the prospect of such liability would raise costs and kill the market. But if that is so—if the green bond market can survive only if issuers do not actually have to commit to financing green activities—why should anyone care whether the market survives?  

Some market participants took comfort in the fact that issuers generally do undertake green projects, notwithstanding the lack of legal enforceability. But at best the green bond label reflects a soft commitment backed by only reputational sanctions. At worst, the label is nothing more than a public relations gimmick layered on top of an ordinary bond. The label allows issuers and investors to burnish their green credentials and justifies the fees paid to the host of intermediaries, such as ratings agencies and second-party certifiers, involved in a green bond issuance. But at least as presently structured, the label is a misnomer. Worse, it runs the risk of duping at least some investors, who might take the ‘bond’ part of green bonds at face value.

Figure 1: Growth of Green Bonds – 2015-2022 (issuances in billions of dollars)

Figure 2: Over Time, Green Bond Issuers Make Fewer Promises, Add More Disclaimers

Quinn Curtis is a Professor of Law at the University of Virginia School of Law.

Mark Weidemaier is a Professor of Law at the University of North Carolina at Chapel Hill.

Mitu Gulati is a Professor of Law at the University of Virginia School of Law.