Climate activists are missing a huge source of capital driving emissions

Climate activists have a?$22 trillion blind spot?when it comes to putting pressure on investors. Yes, there are loud — and sometimes quite effective — campaigns for divestment from high-emission companies. There are also renegade shareholders who force corporate polluters to change their ways. So far, though, there’s almost no climate accountability in the enormous market for corporate debt.

“Debt finance, largely bank loans and bond issuances, accounts for 90% of new capital for fossil-fuel companies,” said Lily Tomson, senior research associate at Jesus College in Cambridge University. Most of the biggest emitters are mature companies whose need for the equity markets — where stocks in public firms are traded — is relatively insignificant compared to their dependence on taking out bonds to borrow money.

While there’s been some pressure on banks to ensure their loans are aligned with global climate goals, it?hasn’t worked. And the pressure on bond investors has been even weaker. That’s the biggest takeaway from a new?Bloomberg Green?investigation?that I worked on with my colleagues Priscila Azevedo Rocha and Todd Gillespie. The story is featured in the new issue of?Bloomberg Markets?magazine.

Read More:?Greenwashing Enters a $22 Trillion Debt Market, Derailing Climate Goals

Bonds are really just fancy loans. Instead of sourcing the money from banks, borrowers rely on public investors. Many of those are people with pensions, whose assets usually include bonds as a safer alternative to owning stocks in a company.

Most of the biggest emitters rely more on bonds for funding day-to-day operations than they do the stock market. According to Bloomberg data, corporate debt for Volkswagen AG stands at €52 billion ($51 billion), ExxonMobil Corp. at $41 billion, and American Airlines Group Inc. at $20 billion.

The advent of green bonds marked the initial foray into moving this giant market toward climate goals. The first green bond was issued in 2008, and since then more than $1 trillion worth has been issued. Wall Street banks and their European counterparts are active players here. Money raised through these bonds is typically stipulated to be used for a specific activity that cuts emissions, such as building a solar power plant.

But if a company doesn’t have green projects to spend money on, they have increasingly been turning to a hot new financial product called?sustainability-linked bonds?(SLB). More than $200 billion worth of SLBs have been issued since 2019.

Money raised with SLBs can be used for any purpose. What sets this financial product apart is that the interest paid on the sum (or coupon, as the jargon goes) is meant to be tied to sustainability goals. Investors are willing to provide cheaper loans to help companies that have greener goals. But if the company doesn’t meet those goals, there’s a penalty: higher interest paid to investors.

We found a glaring flaw in this mechanism. It’s obviously in the company’s interest to set weak climate goals and make it easy to borrow more cheaply. It should likewise be in the investors’ interest to ensure those goals aren’t trivial. But that’s not what happens most of the time, according to?our analysis?of more than 100 SLBs worth almost €70 billion ($69 billion).

Illustrator: Richard A. Chance for?Bloomberg Markets

The?investigation found?either a lack of understanding or indifference among investors about setting good sustainability goals. As long as the bond has a sustainability label, companies are able to get lower interest rates.

The market “is broken,” said Krista Tukiainen, head of market intelligence at the Climate Bonds Initiative. The borrowers found with weak or irrelevant climate goals in their bonds are well-known companies, including fashion icon Chanel, grocery giant Tesco Plc and energy producer Enel SpA.

It doesn’t have to be this way. The vast bond market?can become a real lever?for decarbonizing the world. “I’m a very cynical and skeptical person, but there are some fantastic stories than you can make happen with SLBs,” said Ulf Erlandsson, chief executive officer of the Anthropocene Fixed Income Institute.

Perhaps the borrowing mechanism can work better for nations. Consider that?Chile is using SLBs. The government can spend the bond money as it likes while paying lower interest rates than normal bonds. But the country agreed as a condition to cut its absolute emissions by 15% this decade and increase its share of renewable electricity generation to 50% by 2028.

If it fails, Chile has to pay bond investors higher interest rates. Meeting those goals would deliver significant climate gains, unlike the forgone targets agreed to by investors in corporate SLBs.

Developing countries whose emissions are usually far lower than their industrialized counterparts deserve cheaper loans to reach climate goals. That’s doubly important at a time when the dollar is getting stronger and central banks are increasing interest rates. Access to cheaper loans can be the difference between being able to afford fuel or food for your citizens.

Turning SLBs into a real climate tool depends on investors?becoming more sophisticated?at spotting greenwashing. Our?investigation found?examples of an SLB in which one borrower, Chanel, had already fulfilled a key objective?before?selling the bond to investors. A Swedish private equity firm, EQT AB Group, pulled off the neat trick of issuing a bond tied to a target that it will?soon?set a climate target. Several natural gas pipeline companies created SLBs that managed to exclude the vast majority of their emissions.

Over the past decade climate activists became much more sophisticated about finance. Expanding their emphasis from stocks to bonds is likely just a matter of time. Otherwise, there’s more than enough capital corporate emitters can borrow?to fund activities that will??push average temperatures?above the 1.5°C limit and unleash irreversible?catastrophes.

Akshat Rathi writes the Zero newsletter, which examines the world’s race to cut emissions. You can?email him?with feedback.