Green energy investment boom runs risk of turning to bubble, BIS says

The rapid growth of investment in green energy is raising the prospect of a bubble formation that could burst further down the road, the Bank for International Settlements (BIS) said on Monday.

The value of the S&P500 Global Clean Energy Index, which measures the performance of renewable energy companies, is well above the market’s high valued growth stocks, even after it declined from the peak in January this year.

The price-to-earnings ratio for clean energy stocks is high, attracting investors to these companies. However, in the quarterly report, the Basel-based institution said more analysis is needed to understand how green investing plays out in the credit market.

Moreover, BIS said historical events indicate that assets related to fundamental economic and social change tend to undergo a significant price correction after an initial surge of interest and mentioned the 19th-century railroad stocks and the dot-com bubble as examples.

“Given the very fast growth of the new asset class, there are questions about the possibility that a bubble might develop unless market transparency can be ensured,” authors Sirio Aramonte and Anna Zabai wrote.

“There are signs that ESG assets’ valuations may be stretched, although the available evidence stems from segments that are of indirect concern from a financial stability perspective.”

As the sector is gaining popularity, BIS suggested the Environmental, Social and Governance (ESG) market needs close monitoring for what gets counted as environmentally sustainable, which can identify and manage the financial risks that might arise from a shift in investors’ portfolios.

The market for ESG investing exceeded $35 trillion last year, roughly a third of the global total, Bloomberg reported citing its data.

In March, the European Union introduced anti-greenwashing rules known as the Sustainable Finance Disclosure Regulation (SFDR), requiring fund managers to evaluate and disclose the ESG features of their financial products.

“It will be important not only to assess the benefits of financing the transition to a low-carbon world but also to identify and manage the financial risks that might arise from a shift in investors’ portfolio,” the report said.

 “Proceeding in this direction would involve the collection of adequate data on holders and exposures, with special attention to those that are leveraged and may reside in the less transparent segments of the financial system.”

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