Why Green Bonds Might Not Be So Green After All

An impressive accomplishment of the environmental activist movement over the past 50 years¹—has been the elevation of the appellation “green” into the highest of cultural accolades. “Green” activities, their participants, and advocates automatically achieve highest moral standing akin to that of a widely accepted religion.  

The "Environmental, Social and Governance” (ESG) narrative has become a powerful mainstream tactic by which the moral status of all things “green” has been directly injected into the capital markets.  

But what does “green” really mean in terms of public finance?  

It seems as though there are several categories eligible for the “green” label.  

One category comprises the kinds of financings that have been used to fund public infrastructure projects for water, sewer, flood control, or sanitation long before the advent of any “green” movement.  

The projects thus financed had an undeniable element of environmental protection, but traditionally conceived of as public health measure: that is, protecting people from the diseases that ravaged cities in the 19th and early 20th centuries, along with promoting economic growth and higher living standards.  

An excellent example of another kind of infrastructure financing that achieves “green’ status is the New York City Hudson Yards Infrastructure Corporation’s 2022 $454 mm refunding bond issue. The financings Official Statement² cover displays the “green” status of the bonds prominently in the title, with the appellation “Green Bonds” helpfully printed in green type for any dim soul who doesn’t immediately grasp its significance. A little further down is the assurance that an independent contractor, Kestrel Verifiers, has attested to the bonds’ greenness.  

At the end of the exhaustive Official Statement, Appendix H contains the several page report of Kestrel Verifers, and explains that:

Kestrel finds that the bonds adhere to these principles, in large measure because the debt being refunded originally financed the extension of the Number 7 subway line to the project area—now in operation for several years—that was previously unserved by public transit.

Now, nothing appears inaccurate in any of this. One might separately quibble with the use of tax-exempt bonds to help finance a massive private real estate project as a matter of public policy, but Hudson Yards is at the very least a technologically interesting and innovative public-private partnership, enabling successful mixed-use development atop essentially industrial land use (the Penn Station rail yards), along with the now operational subway extension.  

Furthermore, the project appears to have been very successful, with strong lease-up; this lease-up might be at the possible cost of cannibalizing other areas of Manhattan real estate in a new post-shutdown world where the future of downtown office space is uncertain, but the project developers couldn’t have seen this any more than the rest of us. Kestrel’s description of the project and its mass transit component is accurate, and does comport with the ICMA standards.

So far so, good. But now let’s examine a key definition that Kestrel (not improperly) relies upon (our highlighting):

Zero-direct emissions? Really? What about the massive amounts of electricity required to run a subway system, magnified by its necessarily frequent stops and starts? Electricity, further, which must rely on fossil- or nuclear-fueled generation because subway service can’t cease or pause if it’s a cloudy day, or nighttime, or the wind dies. It is the same flawed logic whereby a Tesla is “green,” apparently because the electricity necessary to recharge it magically emanates from one’s wall-socket, conveniently ignoring both the realities of reliable electric supply and the energy required for the mining and manufacture for its batteries.

The energy generation necessary to operate the NYC subway system is there all right, it’s just out of sight, supplied from the larger regional electric grid. As a reminder to readers of the scale of this necessary generation is the power plant necessary to operate just the very first phase of the present-day system. When the Interborough Rapid Transit (IRT) opened in 1904, it was founded upon a massive, block-long coal-fired power plant ensconced in a classic McKim Meade and White designed shell. The building still sits between 58^th and 59^th street by the West Side Highway, and at its operating core was a vast, ship-sized hall full of generators:

Word-games aside, the extension of the subway line to Hudson Yards has inevitably increased power demands and any associated emissions, despite whatever public good was advanced.

See how this works? “Green” is what you define it, and that definition can be as lenient—or seemingly irrational--as necessary.  

In this case, mass transit is apparently an a priori social good, so it must be pulled into the “green” category.  You can safely feel virtuous in owning these bonds.

Another kind of “green” financing ventures beyond the world of traditional infrastructure financing into the brave world of carbon offsets.  

In October 2022, a new LLC, the Washington DC-based Family Forest Impact Foundation, issued $10 million Series 2022A Taxable Green Bonds. The bonds quite reasonably earned an investment-grade rating because of the direct guarantee of the American Forest Foundation (AFF), whose balance sheet and disclosures—and hence credit strength—are tangible and measurable.  Less tangible and measurable, however, are the green bona fides of the financing itself, the basis for which is described on AFF’s website:  

“A first-of-its-kind carbon accounting methodology for Improved Forest Management (IFM), designed to provide more measurable proof of climate impact and to solve access challenges for small forest landowners, has officially been approved for use in the United States and around the world.

Developed by the American Forest Foundation (AFF) and The Nature Conservancy (TNC) to be used for the organizations’ Family Forest Carbon Program (FFCP), the methodology was approved by Verra’s Verified Carbon Standard, the world’s most widely used voluntary greenhouse gas program, after a rigorous, multi-year evaluation process.”

Essentially, the bonds will fund capital projects amongst participating small scale privately held forests. By improving the forests’ health, and hence CO2 absorption, the participants can then   sell carbon offsets (as quantified and verified by third-party Verra). The intent is to repay these bonds with any carbon offset sales that develop, while the debt is backstopped by the AFF guarantee:

Enrolled landowners are paid to conduct improved forest management practices that increase forest carbon yield over time, such as extending stand rotations and employing limited, sustainable harvesting. To measure the carbon benefit of the project, enrolled properties are compared to the dynamic baseline of matched (unenrolled) forest plots. By measuring the difference between the forests, the methodology pinpoints the project as the sole intervention that contributed to the carbon benefit, providing increased accuracy and transparency to the marketplace… A project has additionality only if the carbon sequestration and storage would not have occurred absent the project.

Who doesn’t love a healthy forest, but does a tree need a bond trustee or a consultant to tell it what to do? To the unenlightened, perhaps, this sounds at best like being paid extra to conduct basic, proper forest management, with most of the work done by trees doing…what they always do, which is to absorb CO2 and water and produce oxygen and glucose through photosynthesis. There appears to be no actual measurement of CO2 absorption, which seems clearly impractical and therefore must be estimated via comparison. One could reasonably suspect that CO2 will do most of the improvement anyway, given that the earth has seen a 14% increase in vegetation over the past 30 years.³ Beyond this, the work of forest management involves building roads, harvesting trees, and cutting and maintaining firebreaks, all of which rely on heavy equipment fueled by… diesel.  

Any carbon offsets thus certified by this “first-of-its-kind carbon accounting methodology" would be acquired by entities—perhaps even a mass transit system—who could then count them toward their “net zero” goals. How alike this is to the medieval purchase of indulgences to wipe away sin; the religious overtones are inescapable.

The ESG narrative always demands close attention to--and questioning of--definitions, details, and context. When you apply serious scrutiny, some of the so-called “Green Bonds” inspired by the ESG religion seem to fall far short of the environmental virtues being signaled with the green label.  

Al Medioli is a seasoned veteran of the capital markets, and investor, and Senior Fellow at The Transparency Foundation.  

¹ That the efforts producing the 1970s environmental clean-up legislation—which did the real work of environmental stewardship, and culminated in the United States having the cleanest air and water of any industrialized society—long pre- dated any such activist movement will be explored in a subsequent essay.

² an Official Statement is the primary bond offering document

³ https://fee.org/articles/rejoice-the-earth-is-becoming-greener/