In October, the world’s leading scientists warned that in as little as 12 years, if not mitigated, global warming could exceed the optimal temperature of 1.5 degrees Celsius, above which catastrophic droughts, floods and extreme heat for millions is predicted.
To keep warming below this level, which is the main goal of the Paris Agreement, the United Nations has said $1.5tn of investment per year is needed.
The issuance of green bonds is one way to provide some of this finance at low cost. However, presently, green bonds, which are essentially the same as normal financial bonds but designated specifically for ‘green’ projects, only make up around 0.5% of all bonds in the market.
To boost their issuance, particularly in middle-income and emerging nations, a coalition of organisations, including the World Bank, The European Investment Bank (EIB), Amundi and others, formed the Global Green Bond Partnership in September.
The group’s aim is to support efforts of sub-national entities, such as cities, states, countries, corporations and private companies, as well as financial institutions, in issuing green bond financing.
The green bond market
Like regular bonds, green bonds are a form of financing that offers issuers a typically low and fixed interest rate of financing for a pre-defined time – a set of lending terms often considered more attractive than regular banking loans.
“One of the very first green bond purchases the EIB [European Investment Bank] supported was for an Italian water utility that used a mini-bond scheme in Italy to achieve lower cost and longer-term funding than would have been possible from a bank,” says Martin Berg, an investment officer in the climate and environment department of the EIB.
“From that perspective we believe it is important to further build this market,” he added.
The EIB was the first bank to issue a green bond in 2002, which was then called a Climate Awareness Bond (CAB). The CAB has since helped finance 160 renewable energy and energy efficiency projects all over the world.
Back then, the green bond market was slow to develop, says Berg, and only in 2013/2014, and subsequent years, has it seen a significant increase in issuance.
According to the new partnership, the green bond market grew from an annual issuance of $3.4bn in 2012 to $161bn in 2017. However, Moody’s Investor Service has cut its green bond forecast to between $175bn and $200bn for 2018. Initially predicted to be $250bn in size worldwide, Daniel Farchy, also from EIB’s climate and environment department, says the market is still emerging.
He adds: “There is now some evidence of slightly cheaper cost of financing and wider participation and issuance.”
Providing financial and technical assistance
All institutions in the Global Green Bond Partnership are already involved in the bond market. Though it’s very early days for the group – they’ve had one organisational call so far – its long-term aim is to share collective expertise with those who want to issue green bonds but lack the expertise or know-how. This will include providing targeted technical assistance, capacity building, de-risking, investing, and underwriting support.
“A large European bank can probably figure this out fairly easily,” says Farchy. “But if you’re a smaller bank in an emerging market or a medium-sized corporation, it may be more difficult. They may view it as more than they can realistically do, but having someone come in and offer financing or technical assistance can be really helpful.”
As an example, he says, with the partnership’s help, a bank that is a borrower can structure the financing as a green bond, instead of doing a standard loan.
The new group will also be developing a Green Bonds Readiness framework and toolkit for organisations to access.
But why green? Definition open to interpretation
Presently, there is little difference between green and regular bonds, so why is it better to use the green label?
For one, it allows the investor to be recognised for doing good things in green finance, says Farchy.
“And if you are an issuer, you will want a wide diversity of investors, rather than risk changes in appetite from a narrow group, and green bonds have typically attracted lots of diversity of interest,” he explains.
“As the process ramps up, the expectation and the evidence is there will be a big difference between green bonds and regular bonds and you’ll start to see a different market dynamic,” he adds.
It is important to note that there is currently no regulation for what makes a bond ‘green’. Of course, it is accepted they should support climate mitigating projects, but the definition of what such a project might be is open to interpretation.
Defining this is rather tricky, as Daniel Shurey, a manager at green finance, Bloomberg New Energy Finance, notes.
“Funding technology to clean up pollution from coal plants might be considered worthy of a green bond in China but wouldn’t be in Germany, for example,” he explains.
Creating standards and best practice for self-regulation and to avoid ‘green washing’ is part of the partnership’s goals.
“This market can only grow in a sustainable way if we have similar standards – if we know what a green bond actually means,” says Berg.
“We want to avoid green washing, because as soon as green bonds become devalued, very quickly the market loses its appeal and the power it can have,” he adds.
What impact can green bonds really have?
According to Shurey, if the partnership can increase the issuance of green bonds it is “of course a great thing”, but he adds that bonds may not be right for every project and even particularly challenging in emerging markets.
“It really depends on your capital requirements and what suits you best rather than if that bond is green or not; furthermore, it’s not common for bonds to be used in emerging markets because the risk is too high and bonds typically have a low yield,” he explains.
He adds that increasing issuance in emerging markets is possible but will likely take a long time.
Andy Vesey, former CEO of AGL Energy, says that currently there is no benefit or premium that a project developer gets from having green bonds, other than a bit more competition and therefore better financing.
“It is not a make or break situation,” he says. “There is capital for good projects and therefore green bonds are not a panacea, they have a benefit because it is another source of financing, but they are not a subsidy or below other market-competing sources of funding.”
However, he adds that the idea of creating a tool kit for green bonds is helpful, and if this had been in place two years ago there might have been more activity in the market now.
“But it is one part of a bigger tool box,” he reiterates.
Berg agrees that green bonds could be boosted further if governments made a point of steering capital markets in a certain direction.
“They could say to institutional investors you need to have X amount of financial products that meet this regulatory requirement, that would be one way,” says Berg. “Or say, if you hold green assets we will account for capital requirement in a different way by perhaps lowering it.”
Some governments are already considering doing this.
As Berg demonstrates, the other value the new partnership will have is bringing industry experts together to share ideas and discuss, in a coordinated way, how to best tap into the trillions of investment dollars floating around capital markets, to bring climate mitigating projects to fruition faster. Such a mammoth task requires continued multilateral effort and agreements, and even radical thinking, to be achieved at the scale required.