Stockholm (NordSIP) – The World Bank (WB), via the International Bank for Reconstruction and Development (IBRD) issued a 9-year US$225 million, principal-protected Amazon Reforestation-Linked Bond on August 13th. According to the WB, this is the largest outcome-linked bond ever priced by the institution.
“Velliv is very pleased to participate in the Amazon Reforestation-Linked Bond. This impact investment goes very well hand in hand with both the carbon-reduction, social and biodiversity priorities of Velliv. Velliv is pleased the transaction has identified Mombak to carry out the groundwork and succeed with this important objective,” said Thor Schultz Christensen, Deputy Chief Investment Officer at Denmark’s Velliv Pension, one of the investors in the reforestation bonds.
The WB reforestation-linked bond has some very interesting features that distinguish it from the usual model of sustainability-linked bonds (SLBs). However, investors should not ignore the risks associated with independent Carbon Credit Registries’ (CCRs) ability to accurately certify carbon removal units (CRUs).
Funds for Reforestation
By virtue of its very nature as a multilateral development bank, all of the WB’s funds are used to finance sustainable development projects. Indeed, the vast majority of the funds from the reforestation-linked bond are to be channelled towards such general sustainable development projects. Thus, tracking the different levels underlying this transaction can help to understand what makes this reforestation-linked bond different from other bonds issued by the WB.
The reforestation link in this bond is in the fact in the fact that US$36 million (16% of the total US$225 million issued), equivalent to the “foregone coupons”, or “the differential between the World Bank ordinary coupon and the guaranteed coupon”, are channelled to reforestation-linked projects, according to the WB.
Once the WB has received the money from the bond investors, it channels the US$36 million to Mombak, a Brazilian Limited Liability Company that develops native reforestation projects to remove carbon dioxide from the atmosphere. Mombak then channels these funds to 11 such carbon removal projects, which generate CRUs, certificates issued by an independent carbon credit registry that attest to the amount of carbon removal facilitated by the projects. Mombak then sells these CRUs to Microsoft. The more CRUs and the higher their price, the more revenue Mombak can generate.
Investors’ Return
The reforestation-linked coupon is tied to the sale of the CRUs. The bond’s coupon is in two parts. On the one hand the coupon includes a fixed guaranteed component, equivalent to approximately 1.745%. In addition, if the projects perform as expected (in terms of generating and monetizing the expected value of CRUs) investors can expect to earn up to a total annualized yield of 4.362%.
“A portion of the revenue generated from this sale will be paid to bondholders in the form of CRU Linked Interest, in addition to the minimum guaranteed coupon the World Bank will pay investors. The bond offers investors a potential financial benefit compared to regular World Bank bonds of similar maturity if the projects and monetization of high-quality CRUs are generated as expected,” the WB explains. At the end of 2023, Microsoft and Mombak entered into an agreement for the sale of 1.5 million carbon removal credits until 2032. The terms of this deal are undisclosed.
“A variety of partners and financing tools are needed to support the Amazon and help the people there pursue better livelihoods, protect its incredible biodiversity, and safeguard its global role in mitigating climate change,” said Jorge Familiar, Vice President and Treasurer, World Bank. “As demonstrated by the historic level of participation in today’s transaction, private investors are eager to connect their financial return to positive development outcomes in the Amazon region. With this largest ever outcome bond we continue to be encouraged by the growing interest in the structure as well as the expanded list of sectors supported.”
The Rest of the Plumbing
CRUs are at the heart of this bond’s structure. According to the WB, “CRUs will be generated by reforesting degraded land: once planted, trees will grow and capture carbon from the atmosphere, storing it in wood. The amount of CO2e sequestered will be assessed through innovative and dynamic methodologies by Mombak and verified by accredited third parties as specified by an independent Carbon Credit Registry such as Verra or Gold Standard.”
HSBC operates as both a lead manager of the bond, but also as an intermediary between the WB and Mombak, channelling the funds from the first to the latter. According to the WB, the “IBRD has entered into a Forward Flow Agreement (FFA)¹ with HSBC to hedge the CRU exposure. Under the FFA, subject to the achievement of milestones by Mombak, IBRD will make payments to HSBC of up to approximately USD 36 million (the differential between the fixed rate coupon on the bond and an ordinary IBRD coupon) to support Mombak’s projects. In return, under the FFA, HSBC will pay IBRD an amount equivalent to the CRU Linked Interest Amount due to the bond investors.” The terms of the relationship between HSBC and Mombak were not disclosed by the WB.
“We are pleased to work alongside the World Bank on this innovative bond which aims to support the reforestation of thousands of hectares of the Brazilian Amazon rainforest. We are committed to helping our clients fund sustainable development projects that make a difference in the climate challenge. It was a privilege for HSBC to structure the transaction and act as sole lead manager on the World Bank’s largest-ever outcome bond issuance to-date,” said Greg Guyett, CEO of Global Banking & Markets, HSBC.
Unlike an SLB
The bond is different from a SLB in one important aspect: Interest alignment. One of the issues with SLBs that is repeatedly highlighted is the fact that their step-up only occurs in case the borrower fails to meet its sustainability targets. In so doing, SLBs attract investors that would benefit from a failure to meet sustainability goals. At the same time, it also creates an incentive for the borrowers to not be particularly ambitious, in order to meet their targets and not be punished.
In this reforestation-linked bond, on the other hand, all incentives are aligned in support of the goal, reforestation. If reforestation
Moreover, the WB also argues that this “reforestation-linked bond is the first bond linking investors’ financial return to the removal of carbon from the atmosphere, differing from past transactions linked to the sale of carbon credits from avoided emissions.”
Unforeseen Risks of the Reforestation Linked Bond
In its FAQ the WB highlights several of the risks underlying this bond, including how failures from Mombak and HSBC could leave investors with lower returns. However, it says nothing of the independent carbon credit registries that are meant to attest to the amount of carbon removal facilitated by the projects.
“The amount of CO2e sequestered will be assessed through innovative and dynamic methodologies by Mombak and verified by accredited third parties as specified by an independent Carbon Credit Registry such as Verra or Gold Standard,” the WB explains.
Given the central role of CRUs in aligning all the players involved in this bond’s chain and pointing them towards reforestation, the role of the companies certifying the amount of carbon removed is crucial. However, this is a very controversial industry, who players, including Verra and South Polehave been under very close public scrutiny due to claims that they have misrepresented facts or engaged in outright fraud. Investors and the WB would be well served by paying particular attention to this aspect of the transaction if they are to avoid flirting with controversy.
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¹An FFA is similar but not identical to a fixed-for-float swap. One of the main differences appears to be that an FFA is characterised by a single payment, whereas a swap is characterised by several payments.
