Financing of infrastructure

With climate change issues higher up the corporate board agenda thanks in no small part to Kyoto Protocol-linked emission reduction targets and momentum gathered from the UN Conference on Climate Change (COP21), appetite for green financing products has been inevitably growing. According to Moody’s Investor Services, green bonds globally were valued at roughly $16.9bn in Q1 2016, with projections that supply will outstrip demand as the market grows to $70bn by 2016 year end as compared with $42.4bn recorded in 2015, which was the highest level for such bonds since they first emerged in 2007.

What are green bonds?

Tied closely to the push to balance out carbon emissions and changing attitudes to energy storage (see our elexica article), the "green bond" moniker covers a range of fixed income debt instruments, the proceeds of which are exclusively applied towards the financing or refinancing of projects or infrastructure assets that are considered environmentally sound.

A number of sector-specific standards do exist - including the International Capital Markets Association coordinated voluntary set of Green Bond Principles (recommending transparency and aiming to promote integrity in the development of the green bond market) and the Climate Bonds Standard (a standard that issuers can have their green bond certified to) - which, when coupled with green bond indices (indices launched by investment banks and credit agencies, designed to help investors benchmark bond performance) act as helpful guidelines. However the absence of a universally accepted "green bond" definition, formalised criteria or compulsory requirements for tracking or reporting on proceeds of issuance of green bonds means that it is left to the issuer to evaluate the bonds’ green credentials and generally manage the bond proceeds, with the market passing judgement thereafter.

Four main categories of green bonds in the market currently are as follows:

Who is issuing them?

Pioneered by international agencies and sub-sovereigns, the green bond market is open to any organisation in any sector, including corporates such as energy giant EDF, technology company Apple Inc. and car manufacturers Toyota and Geely Auto. Notable activity this year has come from a number of Chinese players including Chinese bank, Bank of China, Shanghai Pudong Development Bank, Bank of Qingdao and Industrial Bank and corporates such as BAIC Motor Corporation Ltd. and Link Real Estate Investment Trust.

Chinese green bonds issuances in 2016 so far have included:

Appetite seems to be mainly driven by Chinese central policy support and incentives, which are generally not available in other countries, coupled with China’s actual needs. In this regard:

• In 2013, the State Council of China announced plans to grow a corporate green bond market as part of its efforts to meet the 12th Five-Year Plan objectives to assist China’s transition to a low-carbon green economy. Reports state that China needs at least two trillion yuan ($308.8bn) of green investment annually over the next five years to promote environment protection and reduce the effects of pollution from its rapid industrial growth over the past three decades.
• The National Development and Reform Commission (NDRC) recently issued Guidelines for the Issue of green bonds which include a list of 12 priority areas in energy conservation and emission reductions, climate change and green industries (the Guidelines). The Guidelines exclude enterprises that issue green bonds from bond issue quota restrictions and provide that the size of an applicant’s other corporate credit-based products will not be taken into account by the NDRC when approving the size of a green bond issuance provided that the applicant's asset-liability ratio is lower than 75%.

Why are they attractive?

• Investor demand and diversification: Given the increased focus on sustainable investing and trend towards adopting environmental, social and governance mandates, green bonds may open the door to issuers to access a broader range of investors when compared with the conventional bond investor base. This is particularly relevant in light of the perceived advantage of "use of proceeds" green bonds which tie repayment to the issuer and not the project and thereby avoid project non-performance risk transfer to the investor. Green bonds also provide access to a specific group of investors whose mandate is only to invest in environmentally friendly projects and they are considered to be potentially less volatile than regular bonds since investors tend to favour holding onto green bonds long-term.
• Pricing: Green bonds are generally seen as a more expensive means of raising debt for issuers (largely as a result of the additional costs associated with establishing the bond’s green credentials and on-going monitoring of the bond’s performance against green key performance indicators (KPIs)). However strong continued investor demand often leads to an imbalance between supply and demand for green bonds which generally helps secondary market liquidity and pricing, and recent Barclays research suggests that, on average, investors have been paying an extra 20 basis points for green bonds.
• Reputation: Provided the issuer manages to maintain its post-issuance green standards, being able to demonstrate green credentials is helpful reputationally from both an investor relations and branding perspective. It can also be a good competitor differentiator and, for institutional buyers, demonstrates a commitment to climate change solutions without negatively impacting returns.

Potential drawbacks?

Given the absence of a universal green bond standard and the resulting latitude afforded to the issuer in determining a bond’s green credentials, one of the major challenges for a green bond issuer is the risk of alleged "greenwashing".

There is also the on-going monitoring and reporting burden and the question of cost of capital to consider. Some more cynical bond commentators have seized on the fact that a green bond generates a similar yield to a conventional bond to suggest that green bonds can’t actually be credited with bringing projects to fruition that would not otherwise have attracted funding. If they are financing projects that would have got off the ground anyway, their environmental impact is questionable. So are green bonds the next big thing? Time will tell but projects funded will need to deliver on their "green" benefits for this nascent bond market to achieve credibility long-term.