Have “Green” Projects Finally Found a Sustainable Source of Private Debt Financing?

May 9, 2014

In mid-April 2014, several global financial institutions established a Green Bond Principles Governance Framework and appointed the International Capital Market Association (ICMA) the Green Bond Secretariat.  Many of these financial institutions (e.g., Bank of America Merrill Lynch, Citi, Crédit Agricole Corporate and Investment Bank, and JPMorgan Chase) were also involved in the mid-January 2014 release of the Green Bond Principles.  Nexant discusses below the general contours of the Green Bond concept, and explores prospects for its success in becoming a major source of debt financing for green technology projects worldwide.

What Are Green Bonds?

Green bonds are vehicles for raising debt capital for environmentally beneficial projects.  The January 2014 Green Bond Principles:

  • define four types of green bonds, each with distinct characteristics in regard to (i) recourse to the issuer, (ii) credit/risk exposure, (iii) securitization/collateral, (iv) use of proceeds, etc.;
  • recommend rights and obligations in regard to (i) the use of proceeds, including the requirement that issuers declare the project categories supported by the issue, i.e., renewable energy, energy efficiency, sustainable waste management, sustainable land use, biodiversity conservation, clean transportation and clean water, (ii) project evaluation and selection process, including a review of whether or how a project meets eligibility for green bond financing by falling under a green project category, (iii) proceeds management, including the tracking of proceeds to ensure their due allocation, and (iv) reporting, including the use of quantitative and qualitative performance indicators on green bond investments’ environmental impacts; and
  • suggest best practices for assurance (i.e., ensuring the accuracy and integrity of investments’ sustainability information/data) through (i) consulting an outside environmental consultant to establish a green bond’s eligible project categories, (ii) making publically available a consultant’s recommendations or an auditor’s evaluation, and (iii) performing third party, independent verification and/or certification against fully developed and vetted standards.
     

The April 2014 Green Bond Principles Governance Framework establishes a structure comprising four components, i.e., Members and Observers, an Executive Committee, a Drafting Committee and a Secretariat.  Members elect the Executive Committee which, in turn, elects the Drafting Committee and appoints the Secretariat. With Members thus serving as the Governing Framework’s principal voting body, these four components share responsibility through a system of checks and balances for, inter alia, periodically reviewing and updating the Green Bond Principles, “allow[ing] for diverse stakeholder input into the [Green Bond Principles], provid[ing] effective oversight, and support[ing] [the Green Bond Principles’] further development.”

What Are the Prospects for Green Bonds?

Green Bonds have gained considerable steam in recent months, in light of the number of major global financial sector actors having lent their support to the concept.  While such institutions as the World Bank and the European Investment Bank have been involved in issuing Green Bonds for several years, significant recent or planned Green Bond issuances on the part of TD Bank, Toyota Financial Services, Iberdrola, the city of Johannesburg (South Africa), the regional government of Ile-de-France (France) and the Ontario provincial government (Canada) suggest large-scale buy-in among the private and public sectors alike, across wide ranging geographies and industries.  Green Bond volume has also experienced a steep increase in recent years; the stock of Green Bond issuance over the period comprising 2007-2013 was upwards of USD 24 billion, but Green Bond issuance in 2013 alone was almost USD 12 billion, and Green Bond issuance from January through March 2014 alone has already reached approximately USD 9 billion.

The recent increase in Green Bond transactional activity reflects a broad recognition among large, institutional investors that green projects can provide returns competitive with those of other investments having a similar risk profile.  Additionally, the recent influx into the debt market of corporate Green Bond issuers suggests that financing for green projects is now less dependent than ever on government and development bank support.  The private sector-heavy participation in Green Bonds is certainly welcome news to those involved in climate finance.  As Nexant noted in an April 2013 report on access to green growth financing in developing Asian countries, United Nations Framework Convention on Climate Change (UNFCCC) estimates suggest that 85 percent of all financing needed to properly address climate change must come from private sources given that such public sector and multilateral institution financing as the Green Climate Fund is inadequate to do so alone.

The fact that many green projects are now moving forward in Latin America, the Middle East and Africa on purely commercial terms (i.e., with no subsidy support), a topic about which Nexant recently blogged, will likely further deepen the engagement of institutional investors and corporate bond issuers in green projects.  Moreover, further solidification of the above-mentioned Green Bond Principles and Governance Framework will increase the transparency and integrity of the Green Bond market, which is essential to allaying the concerns of these institutional investors and corporate issuers.