Unit 7: Green and Sustainable Bonds PDF

280 |Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds INTRODUCTION LEARNING OBJECTIVES Debt capital (‘fixed income’) markets play a vital role On completion of this chapter, you will be able to: in alloca...

280 |Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds INTRODUCTION LEARNING OBJECTIVES Debt capital (‘fixed income’) markets play a vital role On completion of this chapter, you will be able to: in allocating capital for finance solutions to firms and projects tackling climate change, environmental and describe the range of debt products available to green transition challenges. They can also help investors and sustainable finance investors; diversify and manage portfolio risk and integrate describe the main types and features of green and responsible and ethical investment approaches. Green sustainable bonds, including green sukuk; and other forms of sustainable bond issuance have explain what is meant by the Green Bond, Social Bond grown rapidly in recent years, exceeding $1.5 trillion and Sustainability-Linked Bond Principles, and the in total in March 2022; those forms include corporate, Sustainability Bond Guidelines, and how these and municipal and sovereign bonds, and an increasing array other frameworks, standards and guidelines support of bond types. As the market grows, so does the risk the development of the green and sustainable bond of greenwashing. Clear guidelines and frameworks for market; and issuers and investors, including the Green Bond, Social Bond and Sustainability-Linked Bond Principles, help describe how securitisation may be used to support maintain market integrity and transparency. smaller green and sustainable finance projects and help these grow and develop. 281 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds 7.1 INTRODUCTION TO DEBT CAPITAL There are also a wide variety of hybrid structures where Yield – The investment return on a bond, calculated lenders have recourse to the income from assets and by dividing the coupon by the current market price. Debt capital (often called ‘fixed income’, because from the issuing company, as well as convertible bonds, As bond prices increase, the yield falls. When bond investors receive agreed interest payments from which can be turned into equity when certain conditions prices fall, the yield increases. When interest rates fall, borrowers) includes a wide range of bonds and other are met. These are less common in respect of green and bond prices usually rise (to make holding a bond more asset-backed securities. The terms ‘debt capital markets’ sustainable finance and are not covered in this course. attractive) – there is an inverse relationship between and ‘fixed income markets’ are used to describe the bond prices and interest rates. business of issuing, managing and trading in these. Overall, bonds are the largest single asset class in the Institutions wanting to raise long-term finance might financial system, with nearly US$130 trillion of total Unlike equity investors, bond investors do not have issue bonds to secure investment without diluting share issuance outstanding, according to the International voting rights or the opportunity to participate in the holdings and without having to repay the principal for Capital Markets Association (2020)1. growth of a company or asset. Conversely, bond holders many years, possibly decades. In many jurisdictions, are not exposed directly to a fall in the stock market value debt financing is often cheaper than equity financing Key features of bonds include: of a company, and they have an earlier call on assets if a due to the favourable tax treatment of debt. Investors company does get into trouble and goes into default (in Issuer risk – How likely is it that the borrower (for provide capital by buying bonds and securities to general, bank loans have first call, then bond holders, and example, a company or a government) will default generate a return, offset liabilities, and diversify portfolios finally shareholders). (i.e. not pay back the principal or interest due on the (geographically, across economic sectors, or in terms of bond)? risk profile). Currency risk – Bonds can be issued in many Debt products fall into two main categories: currencies, and fluctuations in exchange rates may 1. Organisation-guaranteed (“use of proceeds”) bonds, which affect their existing and future value to international raise money for general purposes and are backed investors. by the issuing organisation as a whole. Government Coupon – The rate of interest paid on the face value (sovereign) bonds, municipal bonds and corporate of the bond (usually paid annually, semi-annually, or bonds are the main types by issuer (other issuers quarterly). The higher the risk of default, the higher the include multilateral organisations such as the World interest or coupon needed to compensate investors Bank). Use of the money raised (proceeds) by these for taking on that risk. bonds may be linked to certain qualifying assets or purposes – as we shall see, this is the case in terms of Maturity – How long is it before the investor gets their green and sustainable bonds. money back? The further into the future the maturity date (and hence, the longer the term of the bond), the 2. Asset-backed securities, where interest payments are greater the risk. Some bonds are issued in perpetuity, tied directly to specified assets such as a solar energy with no maturity date. project. Such assets are often placed in a corporate structure called a ‘special purpose entity/vehicle’ set up with the specific purpose of holding the assets. 282 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds Debt is particularly suited for financing the substantial investment costs of many green and sustainable QUICK QUESTION: WHY MIGHT A COMPANY CHOOSE projects, particularly those involving renewable energy such as wind or solar. This is due in part to its suitability TO RAISE FINANCE FOR NEW GREEN AND SUSTAINABLE for projects with large upfront costs that generate PROJECTS BY ISSUING BONDS RATHER THAN OTHER relatively stable and predictable returns over a lengthy SOURCES OF CAPITAL? period of time. Debt, therefore, plays a considerably more important role in financing renewable energy Write your answer here before reading on. infrastructure projects than equity capital does. The IEA (2019), for example, found that renewable energy project finance in 2018 typically exhibited an 80-to-20 ratio of debt to equity2. For most renewable energy projects, the majority of project costs are incurred upfront (e.g. during the construction of a solar array or an offshore windfarm). Ongoing, marginal costs are low, as the sun shines and the wind blows for free - although there will be ongoing maintenance, transmission and other costs. This contrasts with traditional power generation projects, where ongoing marginal costs are high relative to construction costs due to owners and operators having to pay for continued fossil fuel inputs from volatile commodity markets including oil, gas and coal. As we have seen in earlier chapters, the introduction of more realistic and consistent global carbon pricing should see the cost of such inputs rise. 283 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds Although risk profiles differ considerably between different clean technologies and geographies, the typical ‘green’ project lifecycle is characterised by higher levels QUICK QUESTION: CAN YOU THINK OF OTHER EXAMPLES IN of risk in the development and construction phases due to technology and construction risks. Political GREEN FINANCE WHERE HIGH CAPITAL COSTS (CAPEX) ARE and regulatory risk may also be a factor (for example, FOLLOWED BY RELATIVELY LOW OPERATING COSTS (OPEX)? if subsidies for renewable energy are reduced or Write your answer here before reading on. eliminated). Risk levels tend to decrease once a project becomes operational and is producing predictable, stable cash flows to service debt and generate returns, although there are of course issues relating to the variability of sun, wind and tidal energy. In general, though, renewable energy infrastructure projects face a higher cost of capital in the development and construction phases (capital expenditure – capex) and a lower cost of capital when operational (opex). This transition from opex-based systems (i.e. relatively small, upfront capital costs followed by high, variable resource input costs) to capex-based ones (i.e. high, upfront capital costs followed by relatively small marginal costs) is a fundamental change in how we need to think about economics, project returns and finance in the context of green and sustainable finance. It is not only relevant to large infrastructure projects such as the examples given previously, but to many areas of retail finance, too, such as the purchase of an electric vehicle, where relatively high purchase costs are offset by low running costs. 284 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds 7.2 GREEN BONDS response to COVID-193. Despite total sustainable bond Some green bonds carry a recognised label and/or issuance of approximately $1.1 trillion in 2021, we should certification that enables investors to better understand 7.2.1 Introduction to Green Bonds remember that this is still a relatively small proportion how the proceeds are used, while others may be The emergence of green bonds (and the more recent of the $9-$10 trillion of overall issuance during the year. marketed as ‘green’ but not carry a specific label (this evolution of a wider range of sustainable bond types) Total issuance of green and sustainable bond types may or may not indicate a lesser degree or quality has been one of the key developments in green and accounts for less than 5% of total global bond issuance of environmental benefit). As the green bond market sustainable finance in recent years. Green bonds are outstanding (approximately $120 trillion), so despite the grows, there is an increasing risk of greenwashing, where designed to improve the ability of debt capital markets rapid growth in recent years there is still a long way to go financial instruments are marketed as ‘green’, but the to raise capital to finance solutions to climate change, before green and sustainable debt can be described as projects they support are not widely recognised as environmental, social sustainability and transition mainstream. such (for example, supporting power generation using challenges, while also offering investors an opportunity ‘cleaner coal’). The development of market and regulatory to share in financial returns available from the transition Often summarised as ‘transparency’ (in terms of use of frameworks, standards and guidance for issuers and to a more sustainable, low-carbon world. Green and proceeds and disclosure of impacts) and ‘ring-fencing’ (to investors, such as the Climate Bonds Standard developed other types of sustainable bonds can also help investors ensure that funds are used for environmental purposes by the Climate Bonds Initiative, the Green Bond Principles, diversify and manage risk in their portfolios and integrate only), there are four generally agreed aspects to green the EU Taxonomy and the forthcoming EU Green Bond responsible and sustainable investment approaches. bonds that differentiate them from normal, ‘vanilla’ bonds Standard, along with similar national and organisational They have the further advantage of allowing governments (which we explore in more detail in relation to the Green frameworks, will play important roles in maintaining and other issuers to support the flow of capital to priority Bond Principles below): market integrity and transparency. sectors to achieve public policy and other goals, including Use of proceeds – green bonds should be used to The majority of green bonds issued to date are green climate change mitigation and adaptation. finance projects with environmental positive outcomes, ‘use of proceeds’ bonds. This is where the capital raised Green bonds are those where the proceeds raised are such as an offshore wind farm or clean transport is used for specific climate change mitigation and/or allocated to environmental projects or uses. They might External review – the issuers of a green bond should adaptation projects, and the bonds are backed by the be used to raise capital for a wide variety of purposes, evaluate the intended environmental sustainability issuer’s entire balance sheet - known as a ‘recourse- including, but not limited to, renewable energy projects, objectives of projects with the help of a suitably to-the-issuer debt obligation’. This gives confidence to clean transport infrastructure, sustainable buildings, qualified external reviewer investors and rating agencies by significantly reducing (in flood defences, or sustainable forestry and agriculture. most cases) the credit risk and risk of default. Importantly, Disclosure and management of proceeds – the Following 10 consecutive years of growth, total green this approach encourages similar pricing of both green allocation of funds raised from a green bond should be bond issuance reached a record $523 billion in 2021, and conventional ‘vanilla’ bonds from issuers, where independently audited and disclosed to investors and according to the Climate Bonds Initiative, which tracks there is no premium charged for the former. others the issue of green bonds. Other types of sustainable bonds (which we introduce and explore in Section 7.3) Reporting – issuers should report on the – including social, sustainability and transition bonds - environmental impacts achieved – both positive and accounted for nearly $650 billion of issuance during the negative year, with the rapid growth of the market in recent years explained in part by the issue of pandemic bonds in 285 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds There are a wide and growing range of issuers of green ‘use of proceeds’ bonds, and green bonds in general, Key features of the issue are: including: Specified currency: EUR sovereigns (i.e. countries – bonds issued by a Tranche: €750,000,000 recognised government and backed by its credit rating); Face value: €100,000 municipalities (i.e. regions and cities); Coupon: €375 Issue date: 14 October 2020 multilateral and national development banks, and similar development finance institutions (e.g. the World Maturity date: 14 October 2027 Bank, the European Investment Bank); Initially 0.375% per annum fixed rate to the Optional Redemption Date of 14 October 2026 Interest basis: financial institutions; and 3-month EURIBOR + 0.8% floating rate from the Optional Redemption Date to maturity corporate issuers. Lead manager: BNP Paribas In the case study below, we describe a typical green “use Banco Bilbao, Commerzbank, Danske Bank, SEB, Swedbank Joint managers: of proceeds” bond. Expected ratings: Baa1 (Moodys), A- (S&P), A+ (Fitch), A (DBRS) Use of proceeds: Financing and/or refinancing eligible green assets in the categories of: CASE STUDY: A GREEN “USE OF PROCEEDS” BOND – BNP PARIBAS Renewable Energy In October 2020, BNP Paribas issued Euro 750 Energy Efficiency million, 7-year Fixed to Floating Rate Senior Green Buildings Non- Preferred Notes, with the use of proceeds Transportation financing or refinancing eligible, environmentally Water Management and Water Treatment sustainable assets as defined by the bank’s Green Bond Framework, which is aligned to the Pollution Prevention and Control Green Bond Principles. This issue, therefore, can The eligible green assets are further defined in BNP Paribas’ Green Bond Framework. A second-party be described as a ‘green bond’. opinion has been obtained from ISS ESG to confirm the alignment of the Framework with the Green Bond Principles. EY act as the independent verifier for (i) compliance of the green assets selected for the green bonds with the Framework, (ii) impact reporting and (iii) management of the net proceeds. Source: BNP Paribas (2020) 286 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds Green project bonds differ in that they are not backed by an issuer’s whole balance sheet, but by the green project’s or projects’ assets and balance sheet(s) only. Generally, there QUICK QUESTION: HAS THE COUNTRY WHERE YOU LIVE is no recourse to the issuer, which increases the risk profile of the bond - in some cases very significantly - making green AND/OR WORK ISSUED ANY GREEN BONDS, OR HAVE project bonds less attractive to investors, who will therefore THERE BEEN ANY ISSUES FROM COMPANIES OR OTHERS? require a higher return to compensate for the higher risk. Write your answer here before reading on. For this reason, many project bonds are issued, supported by and/or underwritten (in whole or in part) by national and multilateral development banks with a mandate to operate in areas of the market that commercial issuers and underwriters might find unattractive. A common, credit- enhancing support tool used by development banks is ‘first loss provision’. This is where a bond’s risk-return profile is improved by a guarantee to underwrite losses, with the aim of “unlocking” private capital to invest alongside the development bank. The role of development banks is covered in more detail in the next chapter. Green revenue bonds are backed by a project’s pledged revenue streams, usually with no recourse to the issuer. As with project bonds, these tend to be riskier than ‘use of proceeds’ bonds, because revenue streams may be uncertain. In 2016, for example, New York’s Metropolitan Transportation Authority (MTA) issued a $500 million revenue bond to finance improvements to public transport, backed by the revenues from the MTA system. Public transport revenues fell substantially in 2020 and 2021 because of COVID-19, increasing the risk of deferred payments and default to bondholders. Other types of green bonds include green convertible bonds (where debt can be converted into equity of the issuer) and green exchangeable bonds (where debt can be converted into equity of an entity other than the entity, although usually related to it). Whilst it is important to know that these different types of green bonds exist, for the purpose of this study guide we will not examine them in any detail. 287 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds 7.2.2 The Development of the Green Bond Market The diversity of issuers, investors and types of green bonds continues to grow year on year, and the size of issues and Initially, the development of green bonds was led longer bond maturities (lengths) have also increased as the green bond market has matured. A notable development by international financial institutions, including the in recent years has been the growth in sovereign issuers, with G7 countries including Germany, France, Korea, Sweden, International Finance Corporation (IFC) – the World Spain and the UK joining emerging markets issuers such as Chile, Fiji, Serbia and Uzbekistan. France, Germany and the Bank’s private sector lending arm - and multilateral UK are the largest sovereign green bond issuers, with the UK’s £10 billion ($13.7 billion) ‘Green Gilt’ the largest green development banks including the European Investment bond issued in 20219. The European Union has also begun to issue sovereign green bonds, with its first EUR 12 billion Bank (EIB) and the European Bank for Reconstruction and issue in October 202110. Development (EBRD). The EIB issued the first recognised According to the Climate Bonds Initiative, the majority (81%) of green bonds’ use of proceeds in 2021 were allocated green bond in 2007 (referred to as a ‘Climate Awareness towards renewable energy, low-carbon buildings, and low-carbon transport11. Bond’); as of 2020, the EIB’s green bond portfolio had grown to Euro 33.7 billion in 17 currencies, supporting As the global green bond market has grown and developed, related products and services have appeared, including 266 projects in 57 countries 4. The World Bank issued the stock market listings, indices, green bond funds, index funds and ETFs. We explore these in more detail in 7.4. The first security to be referred to as a ‘green bond” in 20085. growth of such related products and services improves the visibility of green and sustainable bonds to investors, encourages secondary market trading, and develops a wider investment base and a deeper pool of capital. The green bond market has developed rapidly since 2007/8. According to the Climate Bonds Initiative (CBI), National green and sustainable bond markets provide an additional source of long-term green and sustainable finance to the end of 2021 a cumulative total of 2,045 issuers to bank lending and equity finance, as well as funds for governments, regions and municipalities to invest in green from 80 countries had issued 9,986 green bonds, not infrastructure and projects. This is especially valuable in countries where demand for green and sustainable investment including other categories of social and sustainable is high, but the supply of long-term bank loans and project or equity finance is limited. Successful bond markets are bonds6. Following more than a decade of growth, as we dependent on well-developed capital markets and supporting infrastructure, which are not always present in all noted previously, annual issuance of all green, social and countries. Examples of developing green (and sustainability) bond markets are found on the next page. sustainable bond types grew to $1.1 trillion in 2021, an increase of 46% from the previous year7. Green bond issuance totalled $523 billion in 2021, an increase of 75% from the 2020 total of $298 billion. According to the CBI, the US was the leading issuer in the global green bond market in 2021, with approximately $80 billion of issuance, and is by some margin the global leader in terms of total green bond issuance to date. China ranked second, with nearly $70 billion of issuance, and Germany third, with approximately $63 billion of issuance8. 288 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds EXAMPLES OF DEVELOPING GREEN BOND MARKETS Country Overview of Developments A1 Issued in 2014 by the World Bank, the first Australian green bond was an AUD 300 million 5-year bond. In 2016, the state of Victoria issued the world’s first sub-sovereign Certified Climate Bond, an AUD 300 million issue with the proceeds financing investments in transport, renewable energy, water and low-carbon buildings12. National Australia Bank (NAB) has been a Australia pioneer in the market; it issued the country’s first Certified Climate Bond in 2014, and the first securitised residential mortgage-backed green bond financing low-carbon homes in 201813. By 2021, the green bond market had grown to some AUD 15.6 billion, according to Westpac14. The Brazilian National Bank for Economic and Social Development (BNDES) published its green bond framework in 2017, supplemented in 2021 by the publication of its sustainability bond framework covering green, sustainability and social bonds15. BNDES issued Brazil’s first green bond in 2018, a $1 billion, 7-year issue to fund new and existing solar and wind power Brazil generation projects. According to the Climate Bonds Initiative, Brazil is now (as of 2021) the largest green bond market in Latin America, with $10.3 billion of total issue from 78 issues and 44 issuers16. Chile’s Green Bond Framework was published by the Ministry of Finance in 201917, and in the same year Chile became the first country from the Americas to issue green bonds on the Chile London Stock Exchange – a $1.42 billion, 30-year bond followed by a EUR 861m, 12-year bond18. According to the Climate Bonds Initiative, Chile led South America in the issue of green, sustainability and social bonds to the end of 2021, with nearly $18 billion raised from 33 bond issues from 16 issuers, approximately half of which are green bonds19. China has been developing its green bond market since 2015, when it issued its first national green bond guidelines. The People’s Bank of China, the China Securities Regulatory Commission and other authorities have published a range of guidance, culminating in 2020 with the Green Bond Endorsed Project Catalogue, revised in 2021, which sets out definitions China for green bond use of proceeds (see 7.2.4 for more details)20. The green bond market has grown rapidly in China, with some $56 billion and $44 billion of total issuance in 2019 and 2020, respectively, and with major issuers including government-backed entities (local governments and water authorities), corporates and financial institutions21. Total issuance is forecast to exceed $100 billion in 202222. France has been in the forefront of the developing green bond market, and a leading issuer of green bonds since its first three municipal green bonds were issued in 2012. There have been a wide range of issues from financial institutions, corporates and government/local government entities since then. France was the second country to issue a sovereign green bond, France a EUR 7 billion, 22-year issue in 2017 followed by several subsequent issues, making France the leading issuer of sovereign green bonds as of 2021, with some EUR 34 billion of total issuance. The Paris-based stock exchange, Euronext, lists a wide range of European-issued green bonds23. Since the issue of the country’s first green bonds (by regional banks) in 2013, the German green bond market has grown rapidly, to rank second only to the US in 2021 with slightly over $60 billion of issuance of green and other types of sustainable bonds in the year24. This is due to Germany’s position at the heart of the EU, and to a favourable policy environment in terms of supporting the development of renewable energy, establishing Germany as a global centre for green and sustainable finance. The German development bank KfW (see Chapter Germany 8) has been one of the largest issuers of green bonds to date. In 2020, Germany launched its first sovereign green bond, a €6.5 billion 10-year issue followed by a €4.6 billion 5-year bond. Issuance of sovereign green bonds totalled €12.5 billion in 2021, and is planned to grow further in 2022 and beyond. The German government has adopted a policy of issuing “twin bonds” – a green bond and a vanilla “twin” are issued concurrently, with the same characteristics, identical in maturity and coupon25. 289 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds Country Overview of Developments A1 According to the Climate Bonds Initiative, India is the fastest growing market for green and other types of sustainable bonds in the Asia-Pacific, with a total issuance to the end of 2021 of India $19.5 billion and a record $6.4 billion of issuance in that year. Approximately 75% of green bonds have been issued by the private sector, with the great majority to date being used to fund renewable energy projects26. The country’s first issue of sovereign green bonds is planned for 2022. With its well-developed capital markets, Japan has been a leader in Asia in the issue of green bonds. The first Japanese green bond was issued in 2014 by the Development Bank of Japan. National Green Bond Guidelines were published by the Ministry of the Environment in 2017, and revised in 2020 to align with the Green Bond Principles and to include guidance for green Japan and sustainability-linked loans27. The Ministry of the Environment has also developed a Green Bond Issuance Promotion Platform, which collates information on the issuance of green bonds28. To the end of 2020, cumulative green bond issuance totalled more than $26 billion, with issuers including government-backed entities such as the Japan Housing Finance Agency and Japan Railway, financial institutions, and large corporates29. In 2017, Nacional Financiera (the Mexican Development Bank) issued the country’s first recognised green bond, a $500 million, 5-year issue. In 2018, the Mexican Green Bond Principles Mexico were published30. To date (2021), a total of 21 green bonds have been issued by 12 issuers, with total issuance of $4 billion31. To support its ambition to become a leading regional and global centre for green and sustainable finance, Singapore has prioritised growing the green bond market. The Monetary Authority of Singapore (MAS) established a Sustainable Bond Grant scheme in 2017 to encourage the issue of green bonds and reduce the cost to issuers32, following which some $5 Singapore billion of green and other types of sustainability bonds were issued in 2019 and 202033. In 2021, the National Environment Agency became the first Singaporean government agency to issue green bonds. The Singaporean government has announced plans to publish a national green bond framework and issue the country’s first sovereign green bonds in 2022, with some $35 billion of issue planned by 203034. South Africa issued the first recognised green bond in Africa in 2012, a ZAR 5 billion, 14-year issue from the Industrial Development Corporation. Since then, the green bond market has grown slowly, with total issuance of approximately $2 billion to the end of 2020, with issuers including government-backed entities, municipalities and, increasingly, financial institutions. South Africa In 2021, the Development Bank of Southern Africa published a green bond framework 35, followed by the issue of its first green bond later that year and plans to significantly increase issuance. Whilst the South African green bond market is relatively small in global terms, it is by far the most successful market in Africa in terms of total issuance and the number of issuers, and may catalyse the growth of markets in the region. Sweden is the largest Nordic market for green and other types of sustainable bonds, and one of the largest global markets, too, with cumulative issuance of more than $43 billion to the end of 2020 and total issuance in that year of $14.4 billion, according to the Climate Bonds Initiative36. Local governments and housing associations are major issuers, with funding often Sweden being used to finance low-carbon buildings and transport. In 2020, the Swedish Ministry of Finance published a framework for sovereign green bonds, followed later in the year by the issue of an SEK 20 billion, 10-year bond37. In September 2021, the UK raised £10 billion from the sale of its first “Green Gilt” (sovereign green bond)38, followed by a second £6 billion issue one month later with a 32-year maturity, UK making it the sovereign green bond with the longest maturity in the world39. Issues are supported by the UK Government’s “Green Financing Framework”, published in June 202140. The Biden Administration has announced ambitious plans to pour $2 trillion into green and sustainable finance – double the EU’s planned spending. Whilst there are rumours of an USA inaugural US sovereign green bond, nothing has materialised at the time of writing ( June 2022). As we noted previously, though, the US is the largest country of issue of green bonds, as a result of regular issues from municipalities and government-sponsored enterprises, including the mortgage securitisation organisations Fannie Mae and Freddie Mac. 290 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds QUICK QUESTION: RESEARCH THE GREEN BOND MARKET IN THE COUNTRY WHERE YOU LIVE OR WORK, OR A COUNTRY YOU KNOW WELL. WHAT HAVE BEEN THE LATEST DEVELOPMENTS AND ISSUES FROM SOVEREIGNS, STATE ENTITIES AND OTHERS? Write your answer here before reading on. 291 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds 7.2.3 The Green Bond Principles aid investors by ensuring the availability of the 2. Process for Project Evaluation and Selection As outlined previously, progress achieved in developing information necessary to evaluate the environmental impact of Green Bond investments; and The issuer of a Green Bond should clearly communicate: the green bond market to date has been rapid and (a) the intended environmental objectives of eligible substantial. Challenges to further scaling up the green assist underwriters by moving the market towards Green Projects, (b) the process by which the issuer has bond market remain, however, including those of standard disclosures that will facilitate transactions. determined eligibility, and (c) information on the social developing credible, verifiable and generally accepted The GBPs recommend a clear process and disclosure and environmental risks associated with the eligible market standards, and increasing awareness and for issuers, which investors, banks, investment banks, Green Projects. understanding of the market. As the green bond market develops, so does the risk of greenwashing, as underwriters, placement agents and others may use In addition, issuers are encouraged to position this issuers seek to take advantage of investor demand for to understand the characteristics of any given Green information within their broader sustainability strategy, issues labelled as ‘green’. Bond. They set out appropriate levels of transparency, to provide information on the alignment of eligible Green accuracy and integrity of information that disclosed and Projects with taxonomies and similar classifications, In order to improve transparency and disclosure, reported by issuers to stakeholders. There are four core to report any relevant environmental standards or promote integrity, and support the development of components: certifications, and to put processes in place to mitigate the green bond market, the International Capital 1. Use of Proceeds any material risks of social or environmental impacts Markets Association (ICMA) developed the Green Bond from the Projects. Principles (GBPs), first published in 2014, revised in 2018, and whose latest version was released in June The cornerstone of a Green Bond is the utilisation of the proceeds of the bond for Green Projects, which should 3. Management of Proceeds 202141. Although they are voluntary process guidelines, the GBPs have been widely adopted by issuers, be appropriately described in the legal documentation The net proceeds of Green Bonds should be credited to investors and other market participants. Although for the bond. Green Projects should provide clear a sub-account, moved to a sub-portfolio, or otherwise formally a bond does not need to be aligned with the environmental benefits, which will be assessed and, tracked by the issuer in an appropriate manner and GBPs to be described as a ‘green bond’, the Principles where feasible, quantified by the issuer. attested to by a formal internal process linked to the have become a generally accepted market standard in issuer’s lending and investment operations for Green Eligible Green Projects should contribute to one or more most major jurisdictions, and are referenced in or used Projects. Whilst Green Bonds are outstanding, the high-level environmental objectives, defined in the 2021 as the basis for many national regulatory frameworks balance of the tracked proceeds should be periodically revision of the GBPs as climate change mitigation, climate and guidance. adjusted to match allocations to eligible Green Projects change adaptation, natural resource conservation, biodiversity conservation, and pollution prevention made during that period. The issuer should make known The GBPs aim to: to investors the intended types of temporary placement and control. The GBPs also contain an indicative list of project categories building on these, but recommend that for the balance of unallocated proceeds. provide issuers with guidance on the key components involved in launching a credible Green issuers refer to taxonomies and similar classifications to Bond; determine eligibility. 292 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds The GBPs encourage a high level of transparency, and Key Recommendations level of detail necessary to fully determine their benefits. recommend that the management of proceeds should The most recent (2021) version of the Green Bond The 2021 version of the GBPs, however, recommends be supplemented by the use of an auditor or other Principles also includes two “Key Recommendations for that issuers refer to taxonomies (and disclose alignment third party to verify internal tracking and the allocation Heightened Transparency” relating to (a) Green Bond with these); it makes more sense to direct issuers to of funds from the Green Bond proceeds. This external Frameworks, and (b) External Reviews: these rather than develop a new taxonomy or other review has become a “Key Recommendation” in the 2021 classification specifically to support the GBPs. revision of the GBPs (see below). Issuers should explain the alignment of their Green Bond(s) with the four core components of the GBPs Despite these criticisms, the Green Bond Principles 4. Reporting (summarised previously) in a Green Bond Framework have undoubtedly brought greater consistency, integrity or similar standard. Ideally, this should also include and transparency to the green bond market, and have Issuers should make, and keep, readily available up-to- helped support its growth and development. They information about the issuer’s overall Paris alignment/ date information on the use of proceeds, to be renewed have also been used as the basis for a range of similar broader sustainability strategy, and issuers are annually until full allocation and as necessary thereafter voluntary process guidelines for other types of green and encouraged to disclose any taxonomies, standards or in the event of new developments. This should include sustainable bonds, including: certifications referenced in project selection. In other a list of the projects to which Green Bond proceeds words, issuers are expected to be as transparent as have been allocated, as well as a brief description of the the Social Bond Principles; possible and to provide as much relevant information projects and the amounts allocated, and their expected the Sustainability-Linked Bond Principles; as possible regarding disclosures, so that investors impact. Where confidentiality agreements, competitive and others can have confidence in the environmental the Sustainability Bond Guidelines; and considerations or a large number of underlying projects credibility of the issue. limit the amount of detail that can be made available, national and institutional green and sustainable bond the GBPs recommend that information be presented in Issuers are advised to obtain third-party external frameworks and guidance. generic terms or on an aggregated portfolio basis (for reviews, both pre-issuance (to ensure alignment of the example, the percentages allocated to particular project Green Bond(s) with the four core components of the The Social Bond and Sustainability-Linked Bond Principles, categories). GBPs) and post-issuance (to verify the allocation of and the Sustainability Bond Guidelines, are covered funds to eligible green projects) 43. in more detail in 7.3. Many financial institutions and Transparency is of particular value in communicating the corporates have also developed their own frameworks expected impact of projects. The GBPs recommend the The wide market acceptance of the GBPs since their for issuing green, social and sustainability bonds. For use of qualitative performance indicators and, where publication in 2014 has certainly helped promote example: feasible, quantitative performance measures, with the consistency, transparency and market integrity. Their key underlying methodology and/or assumptions used in status as voluntary, best practice guidance rather than NatWest’s Green, Social and Sustainability Bond the quantitative determination disclosed alongside these. formal, regulatory standards means that there may, Framework44, which supports the bank’s enhanced The 2021 revision of the GBPs encourages issuers to use, however, be some inconsistency in their application. In strategic focus on climate transition and supporting where possible, the ICMA’s “Harmonised Framework for particular, the GBPs have been criticised for a lack of enterprise. The Framework explicitly references Impact Reporting”42. detail as to what constitutes a ‘green’ project that can the Green and Social Bond Principles, and the be financed by the proceeds of a green bond – in other Sustainability Bond Guidelines, and sets out eligible words, for providing a broad range of project categories use of proceeds for green and social bonds. The supporting environmental sustainability without the 293 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds Framework was independently reviewed by Sustainalytics. The NatWest Framework is examined in more detail in the case study in the next section. QUICK QUESTION: OBTAIN THE GREEN BOND FRAMEWORK EDF’s updated (2020) Green Bond Framework45, FOR YOUR INSTITUTION (IF APPLICABLE) OR AN revised and enhanced since EDF issued its first green INSTITUTION WITH WHICH YOU ARE FAMILIAR. WHAT bonds in 2013, which at that time were dedicated to the construction of new wind and solar installations. ELIGIBLE USE OF PROCEEDS ARE SPECIFIED? The Framework is aligned to the Green Bond Principles Write your answer here before reading on. and the proposed EU Green Bond Standards (although the latter are not yet finalised). In the updated Framework, eligible use of proceeds has been widened to include renewable power generation, investments in existing hydropower facilities, investments in energy efficiency, and biodiversity protection. Vigeo Eris was appointed to independently review the Framework. We examine some examples of other green bond frameworks in the next section. 294 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds 7.2.4 Other Green Bond Frameworks READING: HOW GREEN IS A GREEN BOND? Apart from the Green Bond Principles, many countries, regions and organisations have developed their own The Green Bond Principles (GBPs) are a set of voluntary process guidelines that make recommendations on Green Bond frameworks and similar standards, which are transparency, disclosure and reporting for market participants in order to promote integrity in the market and often aligned with and/or directly reference the Green enable its development. They provide a flexible approach - which has been criticised by some for failing to exclude Bond Principles. In this section, we examine several of the use of proceeds for projects of questionable environmental benefit or sustainability. these. A Euro 500m green bond issued by Repsol Energy in 2017, for example, fits within the GBPs eligible project The EU Green Bond Standard categories, but was not viewed as ‘green’ by some investors because the proceeds finance energy efficiency As we described in earlier chapters, the European Union improvement to oil and gas refineries. Whilst the energy efficiency gains would reduce direct CO2 emissions by (EU) has published an EU Taxonomy for Sustainable an estimated 1.2m tonnes annually by 2020, this is a relatively small fraction of Repsol’s total direct emissions Activities, and this has now come into force. It is a key of nearly 20m tonnes in 2016, and does not account for the much more significant Scope 3 (indirect) emissions. part of the EU’s Action Plan: Financing Sustainable Growth, It does not, therefore, the argument goes, make a significant contribution to the ‘greening’ of Repsol or to the which also aims to: objectives of the Paris Agreement. introduce EU labels for ‘green’ financial products The issue would not be certified under the stricter Climate Bonds Standard, and was not included within to help investors to easily identify investments green bond indices. The issue attracted much commentary in the financial press as an example of potential that comply with agreed criteria, based on the EU greenwashing. This is probably unfair, as Repsol provided clear disclosure on the use of proceeds, and the Taxonomy; issue was externally reviewed in line with the GBP requirements. There was no intention to market the issue as anything it was not. develop an EU Green Bond Standard, aligned with the Taxonomy and existing market standards such as the But is this really a ‘green bond’? Green Bond Principles and Climate Bonds Standard; This example illustrates the challenge of trying to establish frameworks, guidance and standards for a new introduce benchmarks for low-carbon investment product or asset class like green bonds. There is a risk of confusion among investors, and of frustration strategies; and and negative publicity from market participants and others where it is felt these are used – deliberately or improve guidance regarding corporate disclosure of inadvertently - in a misleading manner, or in a way that allows projects and products that meet less stringent climate-related information. criteria to compete with others that adhere to more rigorous requirements. There is a risk of misallocation of capital, as well as a risk to the credibility of particular bond issues and to the green bond market as a whole. Given the EU’s scale and influence, and the launch of the ‘European Green Deal’ that sets out plans for a Source: Climate Bonds Initiative (2017) An oil & gas bond we knew would come eventually: Repsol: Good on GBPs, not so sure on green credentials net zero target for the European Union by 2050, the (online). Available at: https://www.climatebonds.net/2017/05/oil-gas-bond-we-knew-would-come-eventually-repsol-good-gbps-not-so- sure-green-credentials [Accessed: 21 January 2023] implementation of the Action Plan is likely to bring significantly greater regulatory backing to existing, voluntary market standards by embedding them, or versions of them, in EU law. 295 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds The proposed EU Green Bond Standard is intended China’s Green Bond Guidelines All three sets of guidance contained broadly similar to explicitly define what an ‘EU Green Bond’ is, and to Beginning in 2015, China established guidelines for criteria for the issuance of green bonds, based on the enhance the transparency, integrity, consistency and green bonds as part of a wider programme to promote Green Bond Principles: comparability of such bonds. The proposals draw heavily and expand green finance. Like other countries, on the Green Bond Principles; they contain the same four 1. Eligible green project categories China recognises that traditional sources of capital core components (Use of Proceeds, Process for Project are insufficient to meet the investment needs of the The guidance broadly outlined the types of projects Evaluation and Selection, Management of Proceeds, transition a more sustainable, low-carbon economy, and eligible for green bond funding, but used different criteria. Reporting). Independent review by an expert, external is prioritising the development of green bonds and the For example, the NDRC Guidance identified 12 project reviewer will also be required. Unlike the Green Bond green bond market as a key tool for accessing capital categories, while the PBoC Catalogue outlined six. The Principles, the EU Green Bond Standard will have legal from institutional investors. PBoC provided more detail at the sub-sector levels of force. project classification and eligibility criteria within each of China is now one of the world’s largest green bond The EU Taxonomy will be used to determine what its 6 broad categories. markets, with corporate and municipal issuance of investments qualify as being environmentally sustainable approximately $17 billion in 2020. Concerns have 2. Management of proceeds in the context of the proposed EU Green Bond Standard. been expressed, however, that this rapid rise in green Once the Standard comes into force, for a bond issued bond issuance may lead to instances of greenwashing All the guidelines established requirements for managing in the EU to be described as a ‘green bond’ the use of (although this is a challenge for all countries); hence the proceeds. proceeds will need to materially support at least one need for guidelines to ensure market consistency and of the six categories of environmentally sustainable integrity. 3. Requirements on information disclosure activities set out in the EU Taxonomy and the associated Technical Screening Criteria. Some bonds currently In 2015, the People’s Bank of China (PBoC) issued its first The guidelines differed in terms of the frequency and labelled ‘green’ may not meet these criteria, even though guidelines defining criteria and use of proceeds for green extent of reporting. The PBoC, for example, required they do meet the requirements of the Green Bond bonds issued by financial institutions in its ‘Green Bond reporting to be on a quarterly basis, with issuers Principles. Endorsed Project Catalogue’. The Catalogue defined disclosing detail on the use of proceeds in their annual eligible green projects and provided guidelines for these report and a special auditor’s report. As currently proposed (April 2022), the EU Green Bond in six environmentally sustainable areas. Separate Standard will be voluntary, although all issuers of green ‘Green Bond Guidelines’ for domestic corporate bonds 4. Requirements for external review bonds in the EU would have to disclose how the use of (non-financial issuers) were published by the National proceeds aligns with the EU Taxonomy. Some, such as the The guidelines did not require external review, but this Development and Reform Commission (NDRC), and was encouraged by the PBoC and CSRC. As a result, EU Parliament’s Committee on the Environment, Public green bonds issued by listed companies and corporate Health and Food Safety, and the Committee on Economic external reviews have become the norm. asset-backed securities were subject to the China and Monetary Affairs, have called for the EU Green Bond Securities Regulatory Commission’s (CSRC) ‘Guidelines for Having three similar, but not identical sets of guidelines Standard to become mandatory in order to bring greater Supporting Green Bond Development’47. for green bonds could cause confusion and add rigour and standardisation to the issue of green bonds in complexity to a developing market. In addition, the the EU46. guidelines were criticised, especially internationally, for including cleaner coal and natural gas among the eligible uses of proceeds. 296 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds More recently, the Chinese regulatory authorities have been working to develop a joint approach, as well as to harmonise with international frameworks and guidance. QUICK QUESTION: WHY MIGHT CHINA BE KEEN TO ALIGN This resulted in the publication of a Green Bond Endorsed Project Catalogue in 2020 (revised in 2021), jointly ITS GREEN BOND GUIDANCE WITH INTERNATIONAL developed by the PBoC, NDRC and CSRC, which covers all STANDARDS, FRAMEWORKS AND GUIDANCE? domestic green bond issues 48. Write your answer here before reading on. The 2020 Catalogue classifies eligible green projects in six areas: Energy Saving and Environmental Protection Industry Clean Production Industry Clean Energy Industry Ecology and Environment- related Sectors Sustainable Upgrade of Infrastructure Green Services The six high-level categories are subdivided into 25 second level sub-categories, which are further subdivided into third and fourth level sub-categories, giving a considerable level of detail as to eligible projects. The 2020 Catalogue excluded coal and natural gas, but the 2021 revision now includes gas and nuclear (as does the EU Taxonomy). 297 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds The European Bank for Reconstruction and The EBRD applies a strict selection process to ESBs, Development (EBRD) and excludes more universally-accepted unsustainable CASE STUDY: NATWEST GROUP: GREEN, SOCIAL The EBRD was founded in 1991, and is owned by 71 activities such as gambling, pornography and tobacco. & SUSTAINABILITY BOND FRAMEWORK countries and the European Community and European Exclusions also apply to many fossil fuel mining and Investment Bank. Its mandate, via providing project energy activities, as well as those listed on the exclusion In 2019, NatWest Group published its Green, Social finance mainly to the private sector, is to: list of the EBRD’s Environmental and Social Policy. and Sustainability Bond Framework, later updated Positive selection is also undertaken, focusing on the in October 2020. Following the bank’s new purpose- promote a transition to open, market-based environmental benefits of projects and activities – such led strategy under the leadership of CEO Alison economies in more than 30 countries from Central as renewable energy, energy efficiency, or water and Rose, the framework is one of several initiatives Europe to Central Asia and in the Southern and waste infrastructure49. undertaken by the bank to meet its sustainability Eastern Mediterranean; targets. It governs three types of bonds issued by In 2019, the EBRD began to offer two new types of NatWest Group: green bonds, social bonds and apply sound banking principles, ensuring that project sustainable bonds: returns are commensurate with risk; sustainability bonds. finance projects that would not otherwise be solely Climate Resilience Bonds (CRB): These bonds are The Framework –developed in line with the Green funded by commercial banks; and investments in climate change adaption. They are Bond Principles, Social Bond Principles and underpinned by the EBRD’s Climate Resilience Project Sustainability Bond Guidelines - aims to attract ensure that projects facilitate socially and Portfolio, which is consistent with the Climate Bond environmentally sound development. funding for loans and investments that lead to Initiative’s Climate Resilience Principles. To December positive social and environmental impacts. It was 2021, the EBRD has issued €1.2 billion of CRBs, in 12 created to provide a clear and transparent set of Since 2010, the EBRD has been issuing Environmental transactions. criteria to support the transition to a low-carbon Sustainability Bonds (ESB). To December 2021, the bank has issued nearly 100 ESBs totalling €5.5 billion, in a wide Green Transition Bonds (GTB): GTBs focus on economy. variety of currencies. The ESB Framework is aligned with improving key sectors of the economy that are the Green Bond Principles, and proceeds are earmarked dependent on fossil fuels. The bonds aim to finance The NatWest Framework is made up of four key to support: their transition to low-carbon, resource-efficient components: alternatives. Similar to the CRBs above, GTBs are energy efficiency; 1. Use of proceeds: This is the type of investment part of the Green Transition Project Portfolio, which which can be considered. The framework focuses renewable energy; focuses on manufacturing, food production, and on eight key areas for funding: as the construction and renovation of buildings. To water management; December 2021, €1.2 billion of GTBs have been issued, Renewable energy waste management and; in 13 transactions50. Pollution prevention and control pollution prevention and sustainable transport. Both the CRBs and GTBs have frameworks which are Green buildings Internal review is conducted by the EBRD itself, and a more niche and detailed than the more generic ESB Clean transport second, external opinion obtained from Cicero. framework. 298 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds SME lending Female-owned business lending QUICK QUESTION: WHY MIGHT AN ISSUER CHOOSE Access to essential services TO ISSUE A GREEN BOND RATHER THAN ITS VANILLA Affordable housing EQUIVALENT 2. Process for project evaluation and selection: Write your answer here before reading on. A working group is responsible for evaluating projects, and there are several selection criteria. For example, to qualify as a green, social, or sustainable bond, building loans must have an energy certificate performance of A or B, and must adhere to energy-saving processes. 3. Management of proceeds: The funds are managed at a portfolio level by the Group’s Treasury. 4. Reporting: NatWest Group publishes their bonds and framework publicly, so that they are transparent and open to scrutiny. In addition, the Framework also requires that the bonds and the Framework be regularly reviewed by an independent third party, Sustainalytics. This is to help provide objectivity and impartiality to the process. Source: NatWest Group, (2020) Green, Social and Sustainability Bond Framework: Building a purpose-led bank (online). Available at: https://investors.natwestgroup.com/~/media/Files/R/ RBS-IR-V2/green-social-and-sustainability-bonds/gss-bond- framework-oct-2020.pdf [Accessed: 21 January 2023] 299 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds 7.2.5 Advantages and disadvantages of green bonds There may also be several drawbacks to and potential Given the growth of the green bond market in recent disadvantages of green bonds. These include: years as described previously, issuers and others Green bonds are not necessarily additive, but are used must receive - or at least perceive - benefits from the to finance projects and activities by governments and issuance of green bonds compared with traditional organisations that, if they were economically justified, ‘vanilla’ alternatives. The commonly cited benefits and would happen anyway and could be funded through advantages of green bonds include: traditional bonds or other forms of finance. They offer access to a more diversified investor base, By focusing investment on generally new, ‘green’ including institutions and funds with environmental technology and infrastructure, they do not support sustainability mandates, helping issuers raise capital. A organisations’ overall transition to low-carbon survey of treasurers conducted by the Climate Bonds business models. This can be overcome, however, Initiative in 2020 found that 98% of respondents through the use of new types of green bonds, such as said that the issue of a green bond attracted new transition bonds (described in the next section). investors51. The extra costs of issuing green bonds, because of They provide reputational benefits to the issuer, the additional reporting and verification required, demonstrating its commitment to environmental could potentially disincentivise investment in sustainability to policymakers, investors (and potential environmentally sustainable projects and activities (or investors), employees, customers and others. at least lead issuers to use a traditional ‘vanilla’ bond Demand for green bonds tends to be higher than for the same purpose). for traditional ‘vanilla’ alternatives. In the survey of There is a risk of greenwashing where, because of the treasurers noted above, 70% of respondents said lack of strict market and regulatory standards, bonds demand for their green bond was higher than for may be marketed as ‘green’ but in fact support only traditional equivalents. Throughout 2020, green bonds marginal environmental benefits. This can lead to a were oversubscribed compared with ‘vanilla’ bonds. misallocation of capital or jeopardise the credibility of There is emerging evidence of a “greenium” – i.e. a the green bond market as a whole. premium for a green bond - compared with its ‘vanilla’ equivalents. The Climate Bonds Initiative analysed 33 green bonds issued in 2020, and found that 19 showed a greenium52. This means that a bond is issued with a higher price (perhaps because of high demand) and therefore offers a lower yield. 300 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds 7.3 OTHER TYPES OF GREEN AND SUSTAINABLE BONDS QUICK QUESTION: IN YOUR VIEW, WOULD ASSETS AND So far in this chapter we have referred primarily to PROJECTS BEING FINANCED BY GREEN BONDS HAVE BEEN ‘green bonds’, as though they are a single type of debt SUCCESSFULLY FINANCED ANYWAY? instrument. In fact, there are a wide range of green and sustainable bonds, with no single, formal definition Write your answer here before reading on. of what a green and/or sustainable bond is (or is not). Generally, however, green bonds should: be used to finance organisations, projects and activities with outcomes that benefit the environment, (including, but not limited to, climate change mitigation and adaptation) and/or deliver social sustainability benefits; and be issued in accordance with a recognised standard or framework, such as the Green Bond Principles, Social Bond Principles, Climate Bonds Standard, or Sustainability Bond Guidelines. For the purposes of this study guide, when we refer to a green and/or sustainable bond we assume it has met these two criteria. As discussed in previous chapters, however, despite the recent publication of the EU Taxonomy for Sustainable Activities there is as yet no global standard or taxonomy defining exactly what is, or is not, ‘green’ and ‘sustainable’. Different countries and regions may (and do) adopt different definitions. Similarly, national green and sustainable bond standards, frameworks, definitions and guidelines may (and do) differ in their eligible use of proceeds. Furthermore, issuers do not – except where national regulation requires it – need to meet any such standards or guidelines, and can simply describe and market a bond as ‘green’ or ‘sustainable’, although this might be an egregious example of greenwashing. 301 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds There are an increasing number of types of green As an emerging financial instrument, blue bonds may There are four key aspects of the Climate Bonds Standard: and sustainable bonds in addition to the ‘green have a range of characteristics and there is, with the bonds’ described in 7.2. These are described below, in exception of the ADB’s Framework, no recognised set of Identifying qualifying projects and assets, using alphabetical order. principles or guidance setting out agreed use of proceeds the Standard’s eligibility criteria for low-carbon and and similar criteria. There is also nothing to prevent climate-resilient projects and assets 7.3.1 Blue Bonds a green bond’s use of proceeds supporting marine Arranging an independent review, and disclosing the In October 2018, the Republic of the Seychelles issued conservation and biodiversity – in fact, many existing results of that review the world’s first ‘Blue Bond’ to support sustainable green bonds already do this. Ensuring that the use of proceeds is tracked and marine and fisheries projects. Despite the small size of 7.3.2 Climate Bonds reported, at least annually the issue ($15 million), this represented the beginning of an interesting new sector in the green and sustainable ‘Climate Bonds’ are a sub-category of green bonds Having a robust and effective certification system in bond market. It reflects growing policymaker, issuer and where proceeds are used to finance projects specifically place. investor interest in using finance to support marine designed to mitigate or adapt to the effects of climate conservation and biodiversity, often now referred to as change. As we described previously, green bond The Standard is fully aligned with, but builds on, the ‘ocean finance’. proceeds may be used to finance environmental projects Green Bond Principles described previously by including more widely, not just for climate change mitigation and detailed sector-specific criteria for projects and assets The blue bond was pioneered by Nature Conservancy adaptation. In practice, many green bond proceeds are that may be certified by Approved Verifiers as supporting and the World Bank, and is best described as a “debt used to fund climate change projects, however, and the climate change mitigation and adaptation objectives. for seas swap deal”53. A government, in this case the terminology is often used interchangeably. Criteria have been developed, or are being developed, for Republic of the Seychelles, pledges to protect important sectors including water, solar, wind, forestry, low-carbon marine habitats under its jurisdiction, such as coral In this study guide, we use ‘green bond’ as our preferred buildings, bioenergy, geothermal energy, marine energy reefs. In exchange, the World Bank and other investors terminology, except where the context or examples and and low-carbon transport. restructure outstanding sovereign debt, resulting in lower case studies require specific reference to climate bonds. interest rates and annual payments to bondholders. The Climate Bonds Initiative (CBI), introduced earlier in The Standard is separated into pre-issuance The savings are ringfenced and used to support marine this chapter, has developed the ‘Climate Bonds Standard’ requirements, which need to be met by issuers seeking conservation, and to promote sustainable fishing and to provide assurance to investors (via certification) who certification ahead of issuance, and post-issuance other similar measures. want to be able to easily identify and invest in products requirements, which need to be met by issuers seeking that support action on climate change55. A bond that continued certification following issuance. Investors Following the issue of the first blue bond described meets the Climate Bonds Standard, including verification benefit from certification by an Approved Verifier above, use of proceeds bonds with features similar from an external, Approved Verifier, can be described as (overseen by the Climate Bonds Standard Board), and by to those of green bonds have been issued by the a ‘Certified Climate Bond’. not having to conduct their own, potentially costly and Bank of China, the Nordic Investment Bank and the complex monitoring and verification of use of proceeds. Asian Development Bank, among others. The Asian Issuers benefit from being able to demonstrate the Development Bank has developed an “ADB Green and certified nature of the bond to potential investors. The Blue Bond Framework”, which is closely aligned with the green bond market overall benefits from enhanced Green Bond Principles54. consistency and integrity. 302 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds The main differences between the Climate Bonds Standard and the Green Bond Principles are that the former provides more detailed Sector Criteria to QUICK QUESTION: WHAT ARE THE COSTS AND BENEFITS define and describe eligible use of bond proceeds56. These (together with other criteria) are set as OF HAVING MORE STRINGENT STANDARDS AND requirements, rather than as principles, guidelines REQUIREMENTS IN ORDER TO SECURE GREEN BOND and recommendations as they are in the GBPs. The LABELLING OR CERTIFICATION? Climate Bonds Standard, therefore, sets a more rigorous standard for green bonds, but offers less flexibility to Write your answer here before reading on. issuers. 303 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds 7.3.3 SDG/SDG-Linked Bonds To bring greater consistency and comparability to SDG/ achieved and verified. These are not ‘bonds’ in the As the name suggests, SDG and SDG-linked bonds are SDG-Linked bonds (and other categories of sustainability usual sense of a debt instrument, though they are also bonds where the use of proceeds is tied to achieving bonds) and to encourage the harmonisation of issuers’ referred to as ‘Social Impact Bonds’ (see on the next one or more of the UN Sustainable Development Goals bond frameworks, the United Nations Development page). To avoid confusion, this is how we will generally (introduced in Chapter 1). Such bonds may, therefore, Programme (UNDP) has developed and published refer to this type of social bond. support climate change mitigation and adaptation “SDG Impact Standards for Bonds”58. The Standards Impact bonds, structured in a manner similar to green activities, but also a wider set of environmental and are designed to promote sustainable development, bonds, except that proceeds are used to fund projects social sustainability objectives. Some SDG bonds advance the achievement of the SDGs, provide greater delivering positive social benefits. The International include a covenant that links the bond’s coupon to the credibility and rigour to the issue of SDG bonds, and fit Capital Markets Association has published Social issuer’s achievement of, or progress towards, agreed in with existing principles, frameworks and tools whilst Bond Principles (updated in 2021); these are voluntary sustainability objectives, thereby incentivising issuers in addressing gaps in current market practice. They are built process guidelines for issuers of social bonds59. a manner similar to that of sustainability-linked loans as around four interconnected and interdependent themes: Their approach is similar to that of the Green Bond described in the previous chapter. Principles we examined in more detail previously. a. Strategy A number of issuers have published their own SDG Bond b. Management Approach As an example of the latter, in early 2021 NatWest issued Frameworks or similar standards to provide investors a Euro 1 billion affordable housing social bond. Proceeds c. Transparency and others with more information on eligible use of will be allocated to loans to not-for-profit housing proceeds and other key metrics. HSBC’s 2017 SDG Bond d. Governance associations that provide affordable rent, supported Framework, for example, sets out that use of proceeds housing, and shared ownership schemes. may be linked with activities supporting: Each theme is supported by ‘Practice Indicators’ that set out in more detail what needs to be demonstrated by As we noted earlier in this chapter, social bond issuance SDG 3 (Good Health and Wellbeing) issuers to meet the standard. increased significantly in 2020 and 2021 due to SDG 4 (Quality Education) COVID-19, highlighting the links between social issues 7.3.4 Social Bonds (such as education and poverty) and health. Issuance SDG 6 (Clean Water and Sanitation) The term ‘social bond’ can refer to a variety of financial is expected to continue to increase to help fund the SDG 7 (Affordable and Clean Energy) instruments used to fund projects aiming to achieve economic recovery. According to the Climate Bonds positive social – as opposed to environmental – Initiative, a total of $201 billion of social bond issuance SDG 9 (Industry, Innovation and Infrastructure) outcomes, such as improvements in education, was recorded in 202160. Under its SURE programme - SDG 11 (Sustainable Cities and Communities) supporting female entrepreneurship, or reducing designed to finance short-term employment measures SDG 13 (Climate Action)57 recidivism. Whilst positive environmental outcomes may to counter the economic impacts of the pandemic - the also be achieved, they are not the primary focus of the European Union issued nearly EUR 90 billion of social Other institutions, including the AFD (French impact sought. The two main types of social bonds are: bonds between October 2020 and May 2021, and is the Development Agency), Bank Sabadell, Telefonica and the world’s largest issuer of social bonds61. Government of Mexico, have also published SDG Bond ‘Pay for performance’ contracts, usually between the Frameworks. public and private sectors, or between public sector and social enterprises, where a success payment is made on agreed social impact objectives being 304 | Principles and Practice of Green and Sustainable Finance Unit 7: Green and Sustainable Bonds Social Impact Bonds Bonds described previously, except that the latter and should be comparable to a suitable external As described previously, Social Impact Bonds are specifically reference the SDGs and are now supported by benchmark. not ‘bonds’ as such, but rather ‘pay for performance’ the SDG Impact Standards. 3. Bond characteri