14. Green Bonds

Catherine Reichlin Head of Financial Research, Mirabaud & Cie.

Green bonds first appeared in 2007, 1 but it took almost seven years longer for the market linked to sustainable, climate-related projects to really develop. The first to be interested in green bonds were environmentally conscious investors and development banks, such as the World Bank and the EIB. In 2013, public authorities and companies brought momentum to the market, diversifying a business so far dominated by euro-denominated issues. Things really picked up speed in 2014, with the arrival of new issuers and more substantially sized borrowings. A major turning point was the issuance, by GDF Suez (now Engie), of a EUR2.5 billion bond to finance such projects as the construction of wind farms. The bond was oversubscribed almost three times, and 36% of the issue was bought by non-ESG investors, which was critical to “democratise” the field. It wasn’t only energy companies that contributed to this ramp up. Unilever blazed a trail by issuing the first ever green bond to finance the reduction of its carbon footprint. After manufacturing came the finance industry—banks in particular—with governments finally getting involved fairly late in the game, with Poland and later France issuing bonds in 2016 and 2017, respectively.

What Makes a Bond “Green”?

One of the main, albeit not the sole, criteria is that the bond is issued exclusively to finance environmental projects. In 2014, given the growing interest for this market, banks and issuers adopted the Green Bond Principles and entrusted coordination of them to the International Capital Market Association (ICMA) in its capacity as governance body for capital markets. These non-binding principles have four core components: • Use of Proceeds

Process for Project Evaluation and Selection 2

Management of Proceeds

Reporting

The Green Bond Principles have been updated each year since their inception, and the next update will need to take account of recent market

experiences. Toyota, for example, issued a green bond for projects that had yet to be launched, and while waiting for the funds to be invested, the constructor placed the proceeds in money market funds that were not subject to ESG criteria. This incident highlighted the importance of being able to trace funds and their usage leading up to investment. The Green Bonds market is not easy to fool and is self-regulatory to a certain extent. The lack of official regulatory constraints does not mean that the market accepts everything claiming to be a green bond. In 2015, a Chinese corporation generating most of its revenues through renewable energies issued a self-designated green bond without links to any specific projects, traceability mechanisms, or relevant data transparency. ESG investors refused to recognise the bond as green. More recently, the oil company Repsol provided another telling example that fed into the green debate by seeking to raise funds to improve the energy efficiency of its refineries. The market was unwilling to qualify such a bond as green, and therefore it is not included in the green indices. Although the Green Bond Principles are updated each year, this example highlights the importance of better defining the criteria that enable projects to qualify as green.

Specialised rating agencies have emerged to assist issuers looking to release green bonds. Traditional rating agencies are now also surfing on the green bond wave and proposing their own specific green rating methods. Finally, there is the crucial issue of reporting, with a number of issuers now dedicating a chapter of their annual report to project tracking and the use of funds.

How Does a Green Bond Differ from a Traditional Bond?

The main difference between traditional and green bonds is how the funds are put to use. In the case of green bonds, funds must be used exclusively to finance environmental projects, with investors accordingly aware of which projects their funds have been allocated to.

Theoretically speaking there can be no yield spread between traditional and green bonds. In both cases, credit exposure arises from the same balance sheet and financial ratios and similar returns should thus be garnered by each. Green bonds are, therefore, a genuine investment vehicle as opposed to a form of philanthropy.

The green bond market is experiencing a tremendous upswing, setting new records each year. Several structural changes have taken place, in particular the increasing presence of the US dollar and such emerging markets as China and India in the wake of COP 21 as well as the onset of specialised indices and funds. In 2016, green bonds to the tune of USD81 billion, or almost USD10 million per hour, were issued. The market is looking just as dynamic

for 2017, with close to USD56 billion issued in the first half of 2017 3 alone and almost half of second-quarter bonds being issued by new market arrivals.

Can the Market Continue to Grow?

Although the market is constantly expanding, certain questions remain unanswered. Should there be a legal framework surrounding selection criteria? How is environmental impact measured? Do standards need to be drawn up? Should governments incentivise companies to reduce their CO 2 emissions? The cost factor should also be examined, with green bonds costing companies more than traditional loans due to specific rating, traceability, and reporting requirements.

In 2015, historic decisions were made in favour of this promising market. In June, the G7 voted to cut greenhouse gas emissions by 40% to 70% by 2050. Green bonds therefore appeared to be an ideal financing tool, and certain players were of the opinion that they would even represent between 10% and 15% of total bond issues by 2020. The wheels are in motion, with green bonds already accounting for 3% by Q2 2017. In December 2015, the Paris climate agreement, which marked the close of the COP 21, contributed to reaching the forecasts by attracting new players, such as China and India, to the table. The trend will not be jeopardised by Donald Trump’s planned withdrawal from the agreement; indeed it has even highlighted the strength and commitment of the citizens with the launch of the emblematic “We are still in” 4 movement.

Further Reading

• Climate Bonds Initiative. (2016). Bonds and climate change. The state of the market in 2016. Available at: http://www.climatebonds.net/resources/ publications/bonds-climate-change-2016. • The World Bank. (2016). Green bonds. World Bank Green Bonds.

Available at: http://treasury.worldbank.org/cmd/htm/What-are-Green

Bonds-Home.html. • WWF. (2016). Green bonds must keep the green promise! A call for collective action towards effective and credible standards for the green bond market. Available at: http://d2ouvy59p0dg6k.cloudfront.net/downloads/20160609_green_bonds_hd_report.pdf.

Endnotes

1 Climate Bonds Initiative. (2016). History. Available at: https://www.climatebonds.net/ market/history. 2 Non-exhaustive list of categories considered: renewable energy, energy efficiency (including buildings), sustainable waste management, sustainable use of land (including forestry and agriculture), biodiversity conservation, clean transport, sustainable water management, adaptation to climate change. 3 Climate Bonds Initiative. (2017). Climate Bond 2017, Highlights. Available at: https://www. climatebonds.net/resources/reports/green-bonds-mid-year-summary-2017. 4 http://wearestillin.com/.