Green Bonds: How Ford’s Electric Cars Won the Race Against SEC Regulation

The automotive industry has accelerated its transition to sustainable energy. Last week, an electric vehicle company completed one of the largest IPOs on Wall Street. One day later, six carmakers and thirty governments announced that they will only sell zero-emission vehicles by 2040. This shift to clean transportation requires substantial investments, and green bonds could be part of the solution. Ford notably intends to spend $30 billion on electric vehicles and issued $2.5 billion of green bonds on November 8 to finance the project. This is the biggest green bonds issuance ever completed by a US corporation.

Currently, there is no definition of green bonds under US law. As a result, issuers can self-label their bonds as green or provide a third-party opinion certifying their compliance with nonbinding international guidelines, such as the Green Bonds Principles (GBP). Under the GBP, green bonds’ proceeds must be used for eligible green projects (clean transportation, renewable energy, etc.) and respect some core principles related to the use of proceeds and reporting, such as transparency in the selection and management of the green projects and annual reporting. It is this third-party certification option in compliance with the GBP’s standards that Ford chose.

A significant benefit of third-party certification is that it allows investors to externalize their due diligence costs more easily. Instead of spending time and money to assess the sustainability of bonds and determine whether the security is compatible with their investment policies, the investors might simply rely on the third party’s opinion. This is especially relevant because an increasing number of institutional investors, such as BlackRock, integrate sustainability into their investment decisions to reduce systemic risk and attract or retain investors.

This trend creates considerable demand for green bonds. Since 2015, the average market growth of green bonds has been 60%. This high level of demand is also boosted by the current enthusiasm for sustainability-linked projects. For example, Ford’s stock price surged by 5% following the announcement that the company would spend $11 billion on factories dedicated to electric batteries and electric trucks. This positive attitude towards sustainability improves the liquidity of green bonds and encourages some investors to pay a “greenium.” In other words, some investors will be willing to accept lower yields for green bonds as opposed to traditional bonds.

Ford’s offering exemplifies this “greenium” because the green bondholders will not benefit from tax exemptions or higher priority in cases of insolvency but have accepted to receive lower interest rates.

Green bonds are also an opportunity for issuers with credit risk to access low-priced debt. For example, Ford’s credit rating was downgraded from investment-grade (the highest status) to speculative investment at the beginning of the pandemic. The downgrade was justified by the incertitude related to the impact of COVID-19 on the company’s operations. When Ford issued “Covid bonds” to face the financial consequences of its factories’ shutdown, it was only able to borrow with interest rates around 9% versus 3% for its green bonds.

In response, Ford’s CFO John Lawler announced that the company would buy back the “Covid bonds” to reduce its debt-to-equity ratio and issue green bonds to “improve our balance sheet, lower our debt, and lower the cost of our debt considerably.” While Ford remains rated as a speculative investment, it was able to issue $2.5 billion in green bonds due 2032 at an interest rate of 3.250%. The foregoing demonstrates how companies, including those with poor credit ratings, could take advantage of green bonds to improve their balance sheet by accessing debt at lower costs.

But one major issue surrounding green bonds is transparency­­ – that is, some investors have questioned how “green” these bonds really are. Green bonds ostensibly encourage sustainable projects by decreasing the borrowing costs of companies. At the same time, they can reallocate the capital of investors towards green projects. This sounds too good to be true, doesn’t it? Indeed, the lack of binding standards on the meaning of “green” permits “greenwashing” through the issuance of self-labeled green bonds. Green junk-bonds, which do not necessarily deliver green results, are already on the market and might disappoint investors. Moreover, the possibility to obtain a certification from several third parties could create a race to the bottom where each expert would apply lower standards to retain clients and certify their bonds as green.

Improving the transparency of green bonds will require the introduction of specific disclosure requirements. Indeed, SEC Commissioner Allison Herren Lee clarified that there is no general obligation to “reveal all material information.” SEC’s Chair Gary Gensler, therefore, wants to reform the existing guidance on climate risk disclosure by developing mandatory disclosures on climate risks before the end of the year. The SEC should take this opportunity to also provide a single and binding definition of “green bonds.” This would preserve the market’s confidence in the ability of green bonds to fight climate change by creating enforceable minimum standards.

The SEC historically “deferred to the private accounting industry to set standards for financial statements.” It could thus benefit from the creation of the International Sustainability Standards Board, which will develop sustainability disclosure standards. But this might be a lengthy process. For example, the EU is preparing a European Green Bonds Regulation building upon its Taxonomy Regulation. While the Taxonomy Regulation intends to define green investments and entered into force in July 2020, the concrete standards have not been adopted yet. Although the SEC did not win the race against Ford’s electric cars, it could at least provide a safe track for future issuers and investors.