Green Bonds are a specific sub-set of bonds used for clean energy projects, the vast majority of which are in the area of renewable energy and energy efficiency. Green Bond deals can include other types of bonds which, while not formally labelled Green Bonds, are issued by renewable energy companies or for the construction and operation of green assets. As the market develops many of these 'other' types of bonds may enter the Green Bond market.
Brief Overview of Green Bonds1
Green Bonds raise funds for new and existing projects with environmental benefits. They are similar to mainstream bonds with the difference residing essentially in a defined use of proceeds for specific 'green' projects. From a credit perspective, Green Bonds are indistinguishable from other bonds. Operationally, Green Bonds largely function as conventional debt instruments. They are risk-weighted and credit rated in the usual way, based on the creditworthiness of the issuer, and they are generally listed, traded and regulated in the same way as other bonds in the international bond markets. Issuers and the dealers/managers expect pricing and transaction costs to be similar to an issuer's regular bond.
However, there are a number of advantages to issuing a Green Bond as opposed to a regular corporate bond. From the issuer's perspective, a Green Bond: (i) results in the diversification of its investor pool (e.g., greater numbers of asset managers and insurance or pension funds); and (ii) contributes to 'green' investor relations and corporate social responsibility initiatives (something that dovetails with Islamic principles directly). From a dealer/manager's perspective, Green Bonds can be marketed as premium products to their clients as many investors seek to meet sustainability guidelines or criteria in their investment strategies. Green Bonds are an increasingly popular mechanism to meet these commitments.
The Green Bond Principles2
The Green Bond Principles ("GBP") were launched in 20143 in order to develop parameters for creating the Green Bonds instrument. The GBP are voluntary guidelines that recommend transparency and disclosure and promote integrity in the development of the Green Bond market by clarifying the approach for issuance of a Green Bond. The GBP: (i) provide issuers guidance on the key components involved in launching a Green Bond; (ii) aid investors by ensuring availability of information necessary to evaluate the environmental impact of their Green Bond investments; and (iii) assist dealers/managers by moving the market towards standard disclosure which will facilitate transactions.
As there is no standard definition of what constitutes a 'Green Bond', the 'Use of Proceeds' section of a typical Green Bond Prospectus plays a key role in equipping investors in their assessment of whether a given bond is 'green' enough for them. This is reflected in the GBP through the disclosure of use of proceeds. The GBP are not, however, prescriptive as to the form such disclosure should take. As a practical matter this means that an issuer will designate a 'green' use of proceeds in the prospectus or other issuing documentation and then provide summarised information about the 'green' uses, reporting and second party opinions (if any).
Typically in a basic Green Bond, the use of proceeds, reporting and second party opinions do not form part of the terms and conditions of the Green Bond and do not create specific contractual obligations. However, they typically form part of the disclosure documents or are referred to in the disclosure documents.
The GBP provide a minimum standard of process guidelines that recommend transparency and disclosure in the Green Bond market. As a result, the environmental undertakings of Green Bonds issuers are only partially reflected in transaction documentation. A microcosm has developed around the GBP in support of the Green Bond market that involves opinion providers, certifiers and assurers (including accountancy firms, ESG analysts and academics). Some markets and jurisdictions have begun to integrate elements of the voluntary GBP guidelines into domestic Green Bond regulations and mandatory market criteria. In jurisdictions such as China and India that have or seek to develop mandatory regimes, the GBP are the minimum starting point to which additional mandatory requirements are added. For example, the National Association of Financial Market Institutional Investors ("NAFMII")4 in China takes a more active role in setting out: (i) rules for listing Green Bonds; and (ii) the catalogue of Green Bond sectors and projects which define 'green' for that market.
Types of Green Bonds
The GBP identify four types of Green Bonds (additional types may emerge as the market develops):
Green Use of Proceeds Bond – a standard debt obligation for which the proceeds are moved to a segregated account or otherwise tracked by the issuer and attested to by a formal internal process that will be linked to the issuer’s lending and investment operations for projects. The vast majority of Green Bonds currently fall within this category.
Green Use of Proceeds Revenue Bond – a debt obligation in which the credit exposure in the bond is linked to the pledged cash flows of the revenue streams, fees, taxes etc., and the proceeds of the bond are used to fund related or unrelated ‘green’ project(s) such as a utility provider issuing a bond backed by fees on electricity bills.
Green Project Bond – this is a project bond for a single or multiple Green Project(s) for which the investor has direct exposure to the risk of the project(s) with or without potential recourse to the issuer.
Green Securitised Bond – a bond collateralised by one or more specific projects, including covered bonds, ABS, and other structures. The first source of repayment is generally the cash flows of the assets. This type of bond covers, for example, asset-backed securitisations of rooftop solar PV.
Conceptually each of these categories of Green Bonds could be modified in structure and documentation to fit Sukuk requirements.
Green Bond Market
The Green Bond market accounted for US$800 million of issuance in 2007, but has expanded significantly every year since then. Moody's reported in February 2016 that Green Bond issuance for 2016 could exceed US$50 billion5.
Notably, there has been a difference in the approach to the development of Green Bond markets in different jurisdictions – roughly split into markets which, for the time being, rely on a voluntary approach to criteria and reporting (e.g., the GBP, as used by many European Corporate Green Bond issuers and the set criteria that entities such as NAFMII in China require Green Bonds to meet. There is some market debate on the need for: (i) greater clarity on what a Green Bond is and what distinguishes it from regular bonds; (ii) independent certification; (iii) ‘green’ catalogues and definitions; and (iv) ‘green’ covenants and liabilities. While standardisation of disclosure will support credibility and provide criteria for independent validation in the Green Bond market, a balance has to be struck between enhancement and over-regulation. It is important nonetheless to be aware of regional differences in the developing Green Bond market.