Green Bonds are becoming an inexorable investment tool and have experienced a surge of interest in the past decade. Still, doubt remains as to what they actually are, and too many investors still consider Green Bonds to be an ‘exotic’ investment, as opposed to a tool that generates as good, if not better, returns as traditional bonds. The following outlines the constitution and trajectory of the Green Bond.
Back to the beginning
The Green Bond market kicked off in 2007 with AAA investment grade issuance from the World Bank and the European Investment Bank (EIB). The first corporate Green Bonds were issued in November 2013, pushing the overall market size to . The following year marked a turning point as new issues trebled to reach USD36.6bn, Swedish Real Estate Developer Vasakronan being among the main instigators. Issuance soared to a record high in 2016, accounting for USD93.4bn of investment worldwide, according to rating agency Moody’s and the Climate Bond Initiative. Both estimated a surge to over USD200bn in Green Bond issuance for 2017.
Along with national or regional institutions, the World Bank is a major issuer of Green Bonds, being particularly active in the U.S. and India. China is the largest green bond market in the world, while the European Union and the U.S. are among the largest investors. Amid the growing and encouraging trends are issuances from municipal and local governments. The Swedish city of Gothenburg, for example, issued its first Green City Bond in 2013. Massachusetts, California, New York State and the city of Johannesburg launched Green municipal bonds shortly thereafter.
Green Bonds, Green Projects
Green Bonds are created to raise capital and investment for projects with environmental benefits. A Green Bond include any type of debt instrument where proceeds are earmarked to finance Green Projects, which must be detailed in the security’s legal documentation. Green bonds, which can carry tax advantages for the holder, can make for more attractive investments than taxable bonds, while providing a monetary incentive to tackle climate change and promote renewable sources of energy. Designated Green Bonds must provide clear, assessable environmental benefits, which must be quantified by the issuer where feasible. There are currently four types of Green Bonds as described below.
Green Projects are classified as having ‘complementary social benefits’ by the Green Bond Principles. he classification is determined by the issuer, based on its primary objectives for underlying projects. Green Projects are covered by several broad categories for eligibility with the objective of addressing key areas of environmental concern, such as: climate change, the depletion of natural resources, loss of biodiversity, as well as air, water and soil pollution. Green Projects can be aimed at initiatives as varied as: energy efficiency, pollution prevention, sustainable agriculture, fishery and forestry, the protection of aquatic and terrestrial ecosystems, clean transportation, sustainable water management, the cultivation of environmentally friendly technologies, green buildings – and to encourage sustainability in general.
Bonds intentionally mixing green and social projects are referred to as ‘Sustainability Bonds’, which have their own separate guidelines.
4 Types of Green Bonds
The four types of Green Bonds, according to the ICMA, are:
1) ‘Standard Green Use of Proceeds Bond’: a standard recourse-to-the-issuer debt obligation aligned with the GBPs,
2) ‘Green Revenue Bond’: a non-recourse-to-the-issuer debt obligation aligned with the GBPs, in which the credit exposure in the bond is to the pledged cash flows of revenue streams, fees, taxes, etc. and whose use of proceeds go to Green Projects,
3) ‘Green Project Bond’, a project bond for a single or multiple Green Projects in which the investor has direct exposure to the risk of project(s) with or without recourse to the issuer, and which is aligned with the GBPs, and
4) ‘Green Securitised Bond’, a bond collateralised by one or more specific Green Projects, and aligned with the GBPs, where the first source of payment is generally the cash flow of the assets. This type of bond covers e.g. asset-backed securitisations of energy-efficient assets.
Prospects and Futures
The CBI has found in its Q2 2017 analysis that the pool of Green Bond issuers continues to grow, extending investor choice, and that the issuers themselves find they can continually access a broader investor base compared to ‘vanilla bonds’. Among oversubscription and tight pricing as current market features, 54 percent of Green Bonds were allocated to dedicated green investors, with these and ESG-based mandates supporting market growth overall. 62 percent of these were for bonds originating for Developed Markets, versus 25 percent for bonds originating from Emerging Markets.
The subject of Green Bonds is complex, CBI underlines, with limitations on sample data and data regarding the ongoing development of the market. CBI does, however, pick up on positive trends such as an expanding Green Bond market offering investors a broader choice of instruments, despite a lag in large corporate-issued bonds globally. There are signs, CBI’s research suggests, that both issuers and buyers are benefiting from Green Bonds, relative to vanilla bonds.
Green Bond Principles
Green Bonds must be aligned with the four core components of the Green Bond Principles (GBPs), the voluntary process guidelines set by the International Capital Market Association (ICMA) recommending transparency, disclosure and promoting integrity in the development of the Green Bond market by clarifying the approach for issuance of a Green Bond.
The core components are:
1) Use of proceeds,
2) Process for project evaluation and selection,
3) Management of proceeds,
These principles are designed with broad market use in mind, providing issuers guidance on key components involved in launching a credible Green Bond. They also help investors as they require information necessary to evaluate the environmental impact of Green Bond investments. Finally, they assist underwriters by moving the market towards standard disclosures that facilitate transactions. Green bonds should not, under any circumstances, be considered fungible with bonds not aligned with the four core principles of the GBP.
“The Elephant in the Room”
SPP, the Swedish Insurance and Pensions Company, manages SPP’s Green Bond fund, the biggest Green Bond fund in the world in terms of AUM. This fund, however, amounts to a mere USD350mn – pointing towards the discrepancies between figures, talk and action. Helena Lindahl, Senior Portfolio Manager of the fund, is unimpressed with the speed of development – Green Bonds have only really taken off since the Paris Climate Agreement, she suggests, with the market proliferating in part due to Chinese investment and now being worth close to a quarter of a trillion dollars, but the concept of Green Bonds still hasn’t fully struck home.
Meanwhile, there appears to be (at least) a public relations drive towards Green Bonds in Scandinavia in particular – for example, Folksam, the Swedish insurance company, presented a Green Bond acquisition of USD350mn to the United Nations two months ago, Nordea Asset Management has launched an enhanced Swedish-Fixed Income fund, and, Danske Bank was recently hired to design a new framework for the emission of Green Bonds in the context of Swedish Sveaskog’s issuance of its second green bond totalling SEK 1bn, among numerous others in the Nordics.
Whither Green Bonds?
The concept of Green Bonds may be on the upswing, with the facts so far to support it – but ingrained attitudes remain, leaving it still somewhat of a niche enthusiasm. Despite numerous studies showing that Green Bonds enhance returns, while being crucial instruments to contribute to meeting the Paris Climate Accord’s objectives of reducing CO2 emissions, too many institutions and investors still consider it an exotic topic they can pay lip service to without seriously considering or investing in them. Still, the Green Bond universe has, by any quantifiable measure, exploded over the past decade – with good reason: returns for the environment can actually be returns for the individual. In terms of Green Bonds, issuers can speak to the needs of investors in holistic terms that also amount to the needs of humanity in general.
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