The rise of green bonds

The rise of green bonds

The rise of green bonds

Green bonds are those which have an environmental focus. They differ from other bonds because they only finance environmental projects. BNP Paribas says this includes infrastructure projects that contribute to environmentally friendly energy transitions such as renewable energy, energy efficiency, sustainable waste and water management, sustainable land use or clean transport or help make necessary upgrades to adapt to climate change.

A G20 Green Finance Study Group says green bonds are debt instruments used to finance green projects that deliver environmental benefits. A green bond is differentiated from a regular bond by its commitment to use the funds raised to finance or re-finance “green” projects, assets or business activities. Green bonds can be issued by either public or private actors up front to raise capital for projects or for refinancing purposes, freeing up capital and leading to increased lending.

In line with mainstream bonds, green bonds involve the issuing entity guaranteeing to repay the amount borrowed over a certain period of time, and remunerating creditors through a coupon with a fixed or variable rate of return.
And while green bonds remain a relatively small phenomenon, the market is expanding rapidly. In fact, green bond investing According to Climate Bonds Initiatives ‘Global Green Bonds Mid-Year Summary 2017 Report’, in 2017 issuance for first half was a record of US$55.8 billion worldwide.

Another sign of the mounting enthusiasm for green bonds was that in September 2016, the Luxembourg Stock Exchange announced the opening of the “Luxembourg Green Exchange (LGX)”, the world’s first platform dedicated to green financial instruments. It aims to capture a significant chunk of a market that is expected to become enormous.

When the platform opened, 114 Green Bonds were already listed, amounting to over US$45 billion. The bonds meet strict requirements, notably concerning invested funds, which must be “used exclusively for financing or refinancing 100% green projects.”

Why Green Bonds

According to a study prepared for the OECD, an estimated US$6-7 trillion in annual investment will be needed globally over the next 15 years to meet the demand for green investment in sectors such as environmental remediation, energy efficiency, clean energy, clean transportation and green buildings to facilitate the global transition to an environmentally sustainable and low-carbon economy.
Growing concern around climate change exacerbates the need to fund this transition to a low-carbon economy as soon as possible. Private sector investment in low-carbon infrastructure needs to be scaled up significantly to meet climate change goals, including in clean energy.

In line with these needs, ASEAN countries have come together to develop a framework for the issuance of green bonds.

The Asean Capital Markets Forum (ACMF) in March this year endorsed key initiatives to be implemented in 2017 under the ACMF Action Plan 2016-2020 that aims to create investment and business opportunities through greater connectivity, inclusiveness and resilience of capital markets within ASEAN.

One of the key initiatives endorsed at the ACMF’s 26th meeting, hosted by the Securities Commission Malaysia in Kuala Lumpur, is the cooperation between ACMF and the International Capital Market Association (ICMA) to introduce ASEAN green bond standards that will be applied across capital markets in ASEAN.

This initiative will facilitate ASEAn capital markets in tapping green finance to support sustainable regional growth and meet investor interest for green investments and is part of the ACMF’s broader efforts in developing green finance for the region. The ASEAN Green Bond Standards will be developed based on ICMA’s Green Bond Principles (GBP). The standards are intended to provide additional guidance on the application of the GBP, as well as to enhance transparency, consistency and uniformity of ASEAN green bonds which will also contribute to the development of a new asset class.

The G20 study outlined some key benefits of green bonds:

  • Providing an additional source of green financing. Given immense green investment needs, bonds are one appropriate financing instrument to address such projects. As traditional sources of debt financing will not be sufficient in light of immense green investment needs, there is a need to introduce new means of financing that can leverage a wider investor base including institutional investors (such as pension funds, insurance companies and sovereign wealth funds) that manage over US$100 trillion in assets globally. The development of the green bond market can provide an additional source of funding to green lending by banks and green equity financing by investors.
  • Enabling more long-term green financing by addressing maturity mismatch. In many countries, the ability of banks to provide long-term green loans is constrained due to the short maturity of their liabilities and a lack of instruments for hedging duration risks. Corporates that can only access short-term bank credit also face refinancing risks for long-term green projects. If banks and corporates can issue medium- and long-term green bonds for green projects, these constraints on long-term green financing can be mitigated.
  •  Enhancing issuers’ reputation and clarifying environmental strategy. Issuing a green bond is an effective way to develop and implement a credible sustainability strategy to investors and the general public by clarifying how proceeds raised will contribute to a pipeline of tangible environmental projects. Green bonds can thus help enhance an issuer’s reputation along with internal sustainable development policies, as this is an effective way for the issuer to display its commitment towards improving environmental sustainability. These enhancements may result in benefits for product marketing as well as potential government policy incentives for business operations. Setting up a green bond framework also can serve to upgrade issuers’ environmental risk management process due to their commitment to “green” disclosure.
  •  Offering potential cost advantages. While the cost advantage is not yet evident in the current nascent green bond market, it is possible that, once the market attracts a wider investor base both domestically and internationally, a better pricing for green bonds vs. regular bonds may emerge provided demand is sustained. In some countries, government incentives such as tax reduction, interest subsidies and credit guarantees, are also being discussed as options for further reducing the funding costs for green bonds, with the US having already experimented in this area with green property bonds and municipal bonds.
  • Facilitating the “greening” of traditionally brown sectors. The aforementioned benefits of the green bond market can function as a transition mechanism that encourages issuers in less environmentally-friendly sectors to take part in the green bond market (provided they ring-fence proceeds for green projects) and also to reduce their environmental footprint by engaging in green investment activities that can be funded via a green bond. This complements mandatory 'real economy' policies that lead to changes in business models (such as carbon pricing, waste reduction and recycling targets, policies to promote the circular economy, etc.
  • Making new green financial products available to responsible and long-term investors. Pension funds, insurance companies, sovereign wealth funds and other institutional investors that have a special preference for sustainable (responsible) investment and long-term investment are looking for new financial instruments to achieve their investment targets. Green bonds provide these investors with the access to such products and a way for many other investors to diversify their portfolios. The green label is a discovery mechanism that lowers the “search costs” for investors looking for green opportunities in a vast ocean of bonds.

According to the World Bank, climate change affects all of us. But it is expected to hit developing countries the hardest. Its potential effects on temperatures, precipitation patterns, sea levels, and frequency of weather-related disasters pose risks for agriculture, food, and water supply. At stake are recent gains in the fight against poverty, hunger and disease, and the lives and livelihoods of people in developing countries.

“Tackling this immense challenge must involve both mitigation—to avoid the unmanageable—and adaptation—to manage the unavoidable—all while maintaining a focus on its social dimensions.

“Addressing climate change requires unprecedented global cooperation across borders. The World Bank Group is helping support developing countries and contributing to a global solution, while tailoring our approach to the differing needs of developing country partners. We are strengthening and building climate change partnerships with our member governments and a wide array of organizations.”

In 2008, the World Bank launched the "Strategic Framework for Development and Climate Change" to help stimulate and coordinate public and private sector activity to combat climate change. The World Bank Green Bonds is an example of the kind of innovation the World Bank is trying to encourage within this framework.

The World Bank Green Bond raises funds from fixed income investors to support World Bank lending for eligible projects that seek to mitigate climate change or help affected people adapt to it. The product was designed in partnership with Skandinaviska Enskilda Banken (SEB) to respond to specific investor demand for a triple-A rated fixed income product that supports projects that address the climate challenge.

Since 2008, the World Bank has now issued over US$10 billion equivalent in Green Bonds through more than 130 transactions in 18 currencies.

It described its Green Bonds as an opportunity to invest in climate solutions through a high quality credit fixed income product which have:

  •  A triple-A credit quality for the Green Bonds, the same as for any other World Bank bonds.
  • Positive environmental returns by supporting World Bank projects addressing mitigation and adaptation solutions for climate change

 

Photo: Surety Solutions

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