ESG MADE EASY: A GUIDE TO GREEN BONDS Bocconi Impact Investing Group in collaboration with
Nottingham Green Economy Society
2
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
Foreword There has recently been a surge in funds being held in sustainable or green investments. In Europe alone, 48.4% assets under management are classed as sustainable assets. With the markets shifting towards preferring green investments and the development of multiple alternatives to green bonds, knowledge on this topic is advantageous towards understanding the markets better. A Guide to Green Bonds is the first information pack in The University of Nottingham Green Economy Society's 'ESG Made Easy' series, and is brought to you in collaboration with authors from Bocconi Impact Investing Group. The Nottingham Green Economy Society is the fastest growing sustainability-focused society in the UK. With an aim to provide awareness around green finance, innovation and environmental economics, we established the Sustainable Business Review, a sustainability-centric student run magazine. The Bocconi Impact Investing Group is run by an independent group of students dedicated to sharing accurate, timely, and important research related to the growing impact investing industry. Additionally, we look to achieve our mission by facilitating discussions with guests from the industry via the podcast format, and providing ESG ratings for companies to construct a portfolio. Our mains goals are to: educate students and the public on the topic of ESG, promote sustainable development goals and investments, and engage with industry leaders to gain and provide real world insights. This pack will walk readers through the basics of what a green bond is, their uses as well as the different types of green bonds that currently exist. Practical, real-life implementations of green bonds will also be covered throughout the information pack, alongside gauging a future outlook on this topic. The 'ESG Made Easy' series aims to offer high-quality insights into the world of green finance and will be covering a range of topics, including environmental policy and sustainable innovation.
Bocconi Impact Investing Group
Nottingham Green Economy Society
Authors:
Heads of Partnerships:
Tom Mac Pietro Celle Alexander Protic Simone Querqi
Sania Zaffer Marina Symington Andrea Fernandes
The University of Nottingham Green Economy Society
3
Bocconi Impact Investing Group
WHAT IS A GREEN BOND? A green bond, or climate bond, is a fixed-income resource designed to raise funds for environmental and climate initiatives. Generally, these bonds are asset-linked and supported by the balance sheet of the issuing company, so they hold the same credit rating as the other debt obligations of their issuers. It is noteworthy that when we think about “green bonds”, bonds such as social bonds, or ESG/Sustainability/SDG bonds, or other unspecified “sustainable” bonds should not be included.
How Do Green Bonds Work? Investors
1. Investors buy bonds from organisations
Organisations
Green Initiatives
Cash
Dividends 3. Organisations' profit is used to pay back the bond (with interest)
2. Organisations use this cash to invest in green initiatives
Green bonds are designated bonds intended to encourage sustainability and to support climaterelated or other types of special environmental projects. More specifically, green bonds finance projects aimed at energy efficiency, including: 1. Renewable energy (solar, wind, hydro, geothermal, biomass/biofuel/bioenergy, tidal and other renewables) 2. Energy storage, digital energy and energy efficiency industry 3. LED and smart lighting 4. Pollution prevention 5. Sustainable agriculture 6. Green buildings and infrastructure: new LEED, Energy Star, BREEAM or other certified building and energy efficient social infrastructure 7. Fishery and forestry (reforestation, afforestation and land-use) 8. The protection of aquatic and terrestrial ecosystems 9. Clean transportation (electric and hybrid vehicles, fuel cells) 10. Clean water, and sustainable management and waste management.
4
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
WHAT IS A GREEN BOND? They also finance the cultivation of environmentally friendly technologies and the mitigation of climate change. Relevant exceptions to these categories include, but are not limited to, those covering coal and nuclear. Sometimes, a bond may be issued with a higher price, and thus has a lower yield compared to outstanding debt. The bond will price inside its own yield curve. This is known as a new issue concession; when present in a green bond, it is termed as “greenium�. The new issue premium is the extra yield that a buyer receives (and the seller pays) for a new bond compared to the price at which seasoned bonds from the same issuer are trading in the secondary market at the time of issuance. A new issue premium is a standard feature of the bond market. Among sovereign green bonds, France, the Netherlands and Chile 2050 exhibited a greenium. Five sovereign green bonds have priced on their curves, while three have exhibited a normal new issue premium. The French GrOAT has remained inside the vanilla yield curve in the secondary market. This means that subsequent re-openings also benefited from pricing at a greenium. Green bonds are very appealing on the market since they offer tax incentives, while vanilla bonds do not. These tax benefits provide a monetary stimulus for mitigating significant social issues, such as climate change and the push for clean energy sources.
Projects Financed by Green Bonds RENEWABLE ENERGY SOURCES
ENERGY STORAGE
LED AND SMART LIGHTING
POLLUTION PREVENTION
SUSTAINABLE AGRICULTURE
GREEN BUILDINGS AND INFRASTRUCTURE
REFORESTATION
CLEAN TRANSPORT
PROTECTION OF ECOSYSTMES
CLEAN WATER
5
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
WHO DECIDES WHAT CLASSIFIES A GREEN BOND? What counts as "green" is defined differently. The decision was left to the issuers themselves in the early days. Consequently, the World Bank’s environment department ruled on green bond-funded initiatives. Even some of the first private issues were selfproclaimed as green, including one from Toyota in 2014. The self-reporting mechanism was no longer viable as the sector expanded. Bonds are now approved as green after an external regulator has signed off on the bond issue in question under some general rules. The Green Bond Principles are signed by more than 140 major banks and asset managers around the world, which provide comprehensive guidelines that identify common greenness, provide updates on the use of raised funds and encourage external scrutiny. The Centre for International Climate and Environmental Research in Oslo (CICERO), a Norwegian climate research institute, is one of the largest providers of external review on green bonds; while a second possibility is to be certified by the Climate Bonds Initiative (CBI), an NGO. Further screening from private entities, such as environmental consultancies or large auditors, has also risen. The criteria are often very narrow: some geothermal plants, for example, can release as much carbon dioxide as coal-fired plants from CO2 dissolved in the water itself or released in the drilling process from the rock; while the CBI only certifies geothermal plants that mitigate this problem. There are indeed weaknesses in the current setup. One of them is the lack of norms: for example, China's central bank has developed its own regulations that are distinct from international ones, and India is working on its own rules, too.
The standards are ambiguous, and methodologies for external evaluation differ considerably. Most notably, however, the external evaluation process is oblivious to nuances and only gives definitive yes/no judgments. Fortunately, that is beginning to shift in the right direction. Recently, credit rating agencies such as S&P Global and Moody's have begun "green assessment" services that grade bonds on a scale of greenness. Such a system should help environmentally friendly investors better decide how to allocate their money if it ends up winning market share.
6
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
WHY ARE THEY IMPORTANT?
Green Jobs
Fosters Innovation
Economic & Climate Resiliency Socially Responsible Investments
Green Bonds Incentive to develop Public Private Partnerships
Green bonds are important since they can advance adoption of innovative new technologies, finance projects that provide green jobs, and promote economic and climate resiliency across regions. They are a strong weapon to transition communities away from carbon-reliance, in order to achieve the target of $53 trillion in clean energy investment needed by 2035 to keep global warming under two degrees.
Investors are constantly seeking socially responsible investment (SRI) opportunities and, by repeatedly over-subscribing issuances, have voiced a strong appetite for green bonds. While retail investors are asking their brokers and fund managers for sustainable investments, institutional investors are using green bonds to address ESG (Environment, Social, Governance) mandates, something that had been a struggle to handle with fixed-income instruments before Green Bonds. As a result, new investors and new types of investors have been attracted by green bond issuances, providing a potential market for future issuances. Green Bonds are also a fantastic incentive for municipalities to develop PPPs (public private partnerships) in order to promote investment in innovative technologies and energy efficiency. The Morris Model, which has given low cost bonds to a private developer for development in government buildings in Morris County, is an example of this. Green bond issuers will support other municipalities to engage and gain a reputation for financial innovativeness as pioneers in this market. In the funding of sustainable initiatives, early adopters would pave the way for the rest of the world. Government leaders, and government themselves are also invited to engage in working groups and partnerships that form the economy, create expectations and achieve enduring progress, with an incentive to render themselves a forward-looking, creative, and productive reputation.
7
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
WHO ISSUES GREEN BONDS? Green bonds, or any form of bonds for that matter are usually issued by corporations. In the specific case of Green bonds, they are financial instruments used to raise capital for climate and environmental projects. With US elections happening right now and the potential rise in sustainable investing from the Biden Administration, there has been a substantial increase in both interest and capital for the green bond market. The first massive surge of green bonds were issued in 2016 with the vast majority issued from China. Over 36.9 billion dollars was raised for various projects in China according to the Climate Bonds Initiative and China Central Depository and Clearing Company. This number is especially impressive considering the country’s first ever green bond was issued in 2015 by wind company “Gold Wind� for only 300$ million. A massive increase, and one that reflects a growing realization of the imperative of climate change. Now, we have seen a rise in leadership among many regions.
Green Bond Market Interest
$36.9 bn
$264 bn
raised in China
to be loaned
2016: First massive surge of green bonds
Europe: Leading global bonds issuance
> 48% of total market
2019: Corporations issued majority of green bonds
Europe has been leading the charge for Global bonds issuance the last 2 years with additional plans to loan over 264$ billion dollars as part of the larger loan scheme to combat Covid-19. US elections mark a decisive moment in their commitment to green solutions, and markets have reacted accordingly. Moody estimates that in 2019, corporations accounted for the majority of Green Bonds issuance globally, accounting for over 48% of the total bond market. Some of the biggest banks to have issued green bonds in 2019 were Credit Agricole, BNP, HSBC, JP Morgan and Barclays, and many other banks have been increasing their financing or have intent to do so.
8 7
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
WHAT TYPE OF GREEN BONDS ARE OUT THERE?
Green bonds range in a set of different categories, in order to address various investors’ needs. The main types are the following: Corporate Green Bonds: as any other corporate bond, Green Corporate Bonds are issued by corporations, and promise returns on the proceeds of operations. These securities grant recourse rights in case of default on interest or principal payments. Introduced around 2014, one of the first major examples of CGB issuance is Unilever’s $450m green bond, used to “cut in half the amount of waste, water usage and greenhouse gas emissions of existing factories”. Municipal Green Bonds: climate bonds issued by governments. These securities, very similar to other state-issued ones, focus on climate change mitigation by the government. A brilliant example is Fiji’s $50m bond, issued to address population issues related to environmental change. Supranational Green Bonds: issued by international financial enterprises, such as the World Bank, which is the major worldwide issuer of green bonds. Securitized Green Bonds: these are green bonds securitized by portfolios, which can hold corporate bonds or finance environmental projects. In the Green Bond Principles (GBP), Securitized GBs are defined as: a bond collateralised by one or more specific Green Projects, including but not limited to covered bonds, ABS, MBS, and other structures; and aligned with the GBP.” They work like asset-backed securities, but as will be discussed in the next paragraph, they often out-perform them.
UNILEVER'S $450M GREEN BOND issued to cut half the amount of waste, water usage and greenhouse gas emissions
FIJI'S $50M BOND
issued to address population issues related to environemntal change
WORLD BANK $13B BONDS since 2008 through 150 different transactions in 20 currencies
9 7 8
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
ANALYTICAL EXAMPLE OF GREEN BONDS A good real-world example of Securitized GB is BlackRock’s iShares MSCI ACWI Low Carbon Target ETF. It’s a portfolio based on its non-green twin, the iShares MSCI ACWI ETF, which mission, in BlackRock’s words, is “to track the investment results of an index composed of large and midcapitalization developed and emerging market equities with a lower carbon exposure than that of the broad market.” Looking at data, the portfolio has been struggling from its creation in 2014 to the end of 2016. However, in 2017, it faced a steep growth, which led to a 55% figure throughout the three year period 2017-2020. The COVID-19 crisis claimed its toll, dragging the index back to 2015 levels, but following March a new spike pushed it back to an unprecedented 60%. (The figures are computed setting 2014 as year zero, and refer to the growth of an hypothetical sum of money invested at the opening on the portfolio.) The carbon-adjusted security has outperformed its “non-green” twin under a handful of fronts: first of all it trades at an almost twice-as-big premium, resulting in a $55 higher closing price (as of Oct 12, 2020.) Furthermore, the Low Carbon target portfolio yields higher returns, both annually and on the 30 Days SEC Yield figure. To wrap it up, the green alternative has a significantly minor Net Expense Ratio.
Figure 1: Historical data of Net Asset Value of iShares MSCI ACWI (Source: iShares by BlackRock)
10
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
WHAT IS THE FUTURE OUTLOOK FOR GREEN BONDS? As sustainability and the environment become more and more important in our society, it is also good to shift these issues over to the financial industry. Sustainability is about meeting our needs without compromising future generations’ needs. We can subdivide the concept into three main components: environmental conservation, social responsibility, economic development. The first two are pretty straightforward; whilst the latter is where we will focus our attention on and to be more specific, we are interested in understanding what the future ways of ensuring economic growth will look like.
Sustainability is about meeting our needs without compromising future generations’ needs.
HOW CAN CORPORATIONS AND INDIVIDUALS PROMOTE SUSTAINABLE GROWTH IN THE FUTURE? The future is surely looking at green bonds. These are securities which can be very useful under a broad variety of perspectives: easier capital access to sustainability related projects, positive publicity for firms issuing green bonds, greater overall level of investments as individuals get more accustomed to the idea of sustainability, as well as many other examples. Essentially, green bonds are normal bonds that allocate capital to green projects. This aspect may be key to the future of investment as it gives incentives to both the issuer and the buyer to enter these types of contracts. The first quarter of 2020 is a taste of what we can expect from the future of green investments as there was a strong demand for responsible investments, which drove the issuances of green bonds up to €32 billion despite the COVID-19 pandemic. There is still no evidence on why there should be such a strong demand, especially given that there are generally no price advantages related to these securities.
STRONG DEMAND FOR RESPONSIBLE INVESTMENTS DROVE THE ISSUANCES OF GREEN BONDS UP TO
€32 BN In any case, even if returns are important when talking about finance, we should say that pricing should not be the main factor driving growth in green investments. Overall, as firms begin to prioritise CSR and individuals understand that having genuine interest in sustainable economic development will be the only way to have constant growth, we will see an increase in green investments as a general trend in the future.
11
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
ALTERNATIVE TO GREEN BOND INVESTMENTS Green bonds are not only growing bigger, they are also growing broader. Many different kinds of bonds have been issued in recent years and we will surely see their volume increasing in the near future also as an alternative to purely green bonds. Transition Bonds: help funding the ‘transition’ from environmentally damaging projects also known as ‘brown projects’ (coal-based power generation) toward greener projects (such as natural-gas-based power generation), although not completely green projects (as solar photovoltaic power generation could be). Target Linked Bonds: link the yield of the bond to the attainment of specific goals. Enel Spa, Italian utility company, for example tied yield of their bonds to the fulfillment of specific goals within a set date, if it fails to do so the firm will step up the yield otherwise it remains unchanged.
“Green is the ambition, green is the objective. Transition is the way we get there.” Yo Takatsuki, head of ESG research at AXA Investment Managers,
Transition Bonds: Brown energy towards greener energy
These are only two examples of already existing alternatives to green bonds but we can expect a broader set of possibilities for the future.
Target Linked Bonds: Linking bond yield to green goals
10 12
The University of Nottingham Green Economy Society
Bocconi Impact Investing Group
SOURCES Bloomberg Businessweek. 2019. What are green bonds and how ‘green’ is green?. [Online]. [Accessed 5 October 2020]. Available from: https://www.bloomberg.com/news/articles/2019-03-24/whatare-green-bonds-and-how-green-is-green-quicktake Climate Bonds Initiative. 2020. 2019 Green Bond Market Summary. [Online]. [Accessed 27 September 2020]. Available from: https://www.climatebonds.net/files/reports/2019_annual_highlights-final.pdf iShares. 2020. iShares MSCI ACWI ETF. [Online]. [Accessed 3 October 2020]. Available from: https://www.ishares.com/us/products/239600/ishares-msci-acwi-etf iShares. 2020. iShares MSCI ACWI Low Carbon Target ETF. [Online]. [Accessed 3 October 2020]. Available from: https://www.ishares.com/us/products/271054/ishares-msci-acwilow-carbon-target-etf KFK Research. 2019. Green bonds- a sustainable alternative for municipal infrastructure finance?. [Online]. [Accessed 28 September 2020]. Available from https://www.researchgate.net/publication/331564427_Green_bonds__a_sustainable_alternative_for_municipal_infrastructure_finance Mascelluti, E. 2018. Going Green: Analysis of a Sustainable Portfolio. [Online]. [Accessed 3 October 2020]. Available from: https://tesi.luiss.it/21432/1/676751_MASCELLUTI_ELEONORA.pdf Mehta, M. 2020. Green Bonds: Growing Bigger and Broader. [Online]. [Accessed 3 October 2020]. Available from: https://www.msci.com/www/blog-posts/green-bonds-growing-biggerand/01775697227 Moody’s. 2019. Moody's - Global green bond issuance could top $250 billion in 2019 after strong third quarter. [Online]. [Accessed 30 September 2020]. Available from: https://www.moodys.com/research/Moodys-Global-green-bond-issuance-couldtop-250-billion-in--PBC_1201931 Mouly, M. 2020. Diverse green bonds will build the future faster. [Online]. [Accessed 2 October 2020]. Available from: https://www.internationalinvestment.net/opinion/4012110/diverse-green-bondsbuild-future-faster Statista. 2019. Leading European banks for green bonds underwriting in 2019, by value of bonds. [Online]. [Accessed 29 September 2020]. Available from: https://www.statista.com/statistics/754872/value-of-green-bonds-issued-by-selected-europeanbanks/ The Economist. 2017. What makes bonds “green”?. [Online]. [Accessed 26 September 2020]. Available from: https://www.economist.com/the-economist-explains/2017/07/04/what-makesbonds-green The World Bank. IBRD Funding Program. [Online]. [Accessed 3 October 2020]. Available from: https://treasury.worldbank.org/en/about/unit/treasury/ibrd/ibrd-green-bonds
ESG Made Easy: A Guide To Green Bonds Green Economy Society Nottingham nottinghamgesoc@gmail.com
ESG Made Easy 2020. Published November 2020.
Nottingham Green Economy Society
Bocconi Impact Investing Group